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An Adverse Selection Model of Optimal Unemployment Insurance

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Author Info
Hagedorn, Marcus (IZA Bonn)
Kaul, Ashok (IZA Bonn)
Mennel, Tim () (Center for European Integration Studies, University of Bonn)
Abstract

We derive the shape of optimal unemployment insurance (UI) contracts when agents can exert search effort but face different search costs and have private information about their type. We derive a recursive solution of our dynamic adverse selection problem with repeated moral hazard. Conditions under which the UI agency should always offer separating contracts are identified. We show that the good searcher receives an information rent and that the bad searcher receives the minimal entitlement. From a methodological point of view, we achieve a precise characterization of the sets of jointly feasible entitlements. This allows us to map our analytical results one-to one to a numerical algorithm. According to our results the contract for the good searcher has a decreasing benefit profile, as the one he would be offered in a pure moral hazard environment. In contrast, the contract of the bad searcher is distorted by an adverse selection effect, so that it tends to have an upward-sloping benefit profile. We provide a comparative static analysis of changes in various parameters of our model.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 681.

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Length: 50 pages
Date of creation: Dec 2002
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Handle: RePEc:iza:izadps:dp681

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Related research
Keywords: unemployment insurance; adverse selection; moral hazard;

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Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
J65 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment Insurance; Severance Pay; Plant Closings

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Hassler, John & Rodríguez Mora, José V., 2002. "Should UI Benefits Really Fall Over Time?," IZA Discussion Papers 622, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  2. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, vol. 58(4), pages 757-82, July. [Downloadable!] (restricted)
    Other versions:
  3. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Blackwell Publishing, vol. 54(4), pages 599-617, October. [Downloadable!] (restricted)
  4. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Blackwell Publishing, vol. 59(3), pages 427-53, July. [Downloadable!] (restricted)
  5. Dale T. Mortensen, 1983. "A Welfare Analysis of Unemployment Insurance: Variations on Second Best Themes," Discussion Papers 549, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  6. Atkinson, Anthony B & Micklewright, John, 1991. "Unemployment Compensation and Labor Market Transitions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 29(4), pages 1679-1727, December. [Downloadable!] (restricted)
  7. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  8. Williamson, Stephen D. & Wang, Cheng, 1999. "Moral Hazard, Optimal Unemployment Insurance, and Experience Rating," Working Papers 99-03, University of Iowa, Department of Economics. [Downloadable!]
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  9. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August. [Downloadable!] (restricted)
  10. Shavell, Steven & Weiss, Laurence, 1979. "The Optimal Payment of Unemployment Insurance Benefits over Time," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1347-62, December. [Downloadable!] (restricted)
    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Hairault, Jean-Olivier & Langot, François & Ménard, Sébastien & Sopraseuth, Thepthida, 2009. "Optimal Unemployment Insurance for Older Workers," IZA Discussion Papers 4071, Institute for the Study of Labor (IZA). [Downloadable!]
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