DP9864 Hidden Insurance in a Moral Hazard Economy
|Author(s):||Giuseppe Bertola, Winfried Koeniger|
|Publication Date:||March 2014|
|Keyword(s):||Constrained efficiency, First-order approach, Hidden action, Principal agent|
|JEL(s):||D81, D82, E21|
|Programme Areas:||Labour Economics, Financial Economics, Industrial Organization|
|Link to this Page:||www.cepr.org/active/publications/discussion_papers/dp.php?dpno=9864|
We consider an economy where individuals privately choose effort and trade competitively priced securities that pay off with effort-determined probability. We show that if insurance against a negative shock is sufficiently incomplete, then standard functional form restrictions ensure that individual objective functions are optimized by an effort and insurance combination that is unique and satisfies first- and second-order conditions. Modeling insurance incompleteness in terms of costly production of private insurance services, we characterize the constrained inefficiency arising in general equilibrium from competitive pricing of non-exclusive financial contracts.