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Moral Hazard and Background Risk in Competitive Insurance Markets

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  • JAMES A. LIGON
  • PAUL D. THISTLE

Abstract

We examine the effect of background risk on competitive insurance markets with moral hazard. If policy‐holders have non‐negative prudence, then background risk does not decrease effort and, when effort increases, expands the set of feasible policies. However, the effect of background risk on equilibrium is indeterminate. We analyse the choice between stock and mutual insurance; mutual insurance is equivalent to a fair policy plus background risk. Our results imply that competitive insurance markets with moral hazard should be dominated by stock insurers.

Suggested Citation

  • James A. Ligon & Paul D. Thistle, 2008. "Moral Hazard and Background Risk in Competitive Insurance Markets," Economica, London School of Economics and Political Science, vol. 75(300), pages 700-709, November.
    • Handle: RePEc:bla:econom:v:75:y:2008:i:300:p:700-709
    DOI: 10.1111/j.1468-0335.2007.00650.x
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    References listed on IDEAS

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    Cited by:

    1. Hao Zheng & Yi Yao & Yinglu Deng & Feng Gao, 2022. "Information asymmetry, ex ante moral hazard, and uninsurable risk in liability coverage: Evidence from China's automobile insurance market," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 89(1), pages 131-160, March.
    2. Francesca Barigozzi & Renaud Bourlès & Dominique Henriet & Giuseppe Pignataro, 2017. "Pool size and the sustainability of optimal risk-sharing agreements," Theory and Decision, Springer, vol. 82(2), pages 273-303, February.
    3. Tang, Lin & Luo, Xiaofeng, 2021. "Can agricultural insurance encourage farmers to apply biological pesticides? Evidence from rural China," Food Policy, Elsevier, vol. 105(C).
    4. Xudong Fu & James A. Ligon, 2010. "Exercises of Executive Stock Options on the Vesting Date," Financial Management, Financial Management Association International, vol. 39(3), pages 1097-1126, September.
    5. Peter, Richard & Richter, Andreas & Thistle, Paul, 2017. "Endogenous information, adverse selection, and prevention: Implications for genetic testing policy," Journal of Health Economics, Elsevier, vol. 55(C), pages 95-107.

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