Certainty equivalent with normal truncated lotteries: an application for risk valuation of a health insurance policy in Mexico

Abstract

This paper introduces a family of measures of welfare under uncertainty based on the certainty equivalent under the special case of normal truncated lotteries with constant risk aversion. It presents an application to the welfare gains from providing a public health insurance policy, and estimates the distribution of gains from reducing the risk in the households' net consumption. Using the Mexican National Household Income Expenditure Survey (ENIGH) for 2004, a calibration exercise is performed to test the model's implications. For a household with constant risk aversion/risk tolerance of 1 and facing a health expenditure shock with a mean-variance of $8-24 per quarter, the insurance policy would imply a consumption gain of 1.8 percent.