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An Adverse Selection Model of Optimal Unemployment Insurance

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  • Hagedorn, Marcus

    ()
    (University of Oslo)

  • Kaul, Ashok

    ()
    (Saarland University)

  • Mennel, Tim

    ()
    (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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Bibliographic Info

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

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Length: 51 pages
Date of creation: Dec 2002
Date of revision:
Handle: RePEc:iza:izadps:dp681

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Keywords: unemployment insurance; adverse selection; moral hazard;

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References

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  1. Marcus Hagedorn & Ashok Kaul & Tim Mennel, 2007. "An Adverse Selection Model of Optimal Unemployment Insurance," IEW - Working Papers 315, Institute for Empirical Research in Economics - University of Zurich.
  2. Doepke, Matthias & Townsend, Robert M., 2006. "Dynamic mechanism design with hidden income and hidden actions," Journal of Economic Theory, Elsevier, vol. 126(1), pages 235-285, January.
  3. Wang, Cheng & Williamson, Stephen D., 2002. "Moral hazard, optimal unemployment insurance, and experience rating," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1337-1371, October.
  4. Abreu, Dilip & Pearce, David & Stacchetti, Ennio, 1990. "Toward a Theory of Discounted Repeated Games with Imperfect Monitoring," Econometrica, Econometric Society, Econometric Society, vol. 58(5), pages 1041-63, September.
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  7. Chang, Roberto, 1998. "Credible Monetary Policy in an Infinite Horizon Model: Recursive Approaches," Journal of Economic Theory, Elsevier, vol. 81(2), pages 431-461, August.
  8. Bruce D. Meyer, 1995. "Lessons from the U.S. Unemployment Insurance Experiments," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 91-131, March.
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  16. Hassler, John & Rodriguez Mora, José V., 2002. "Should UI Benefits Really Fall Over Time?," IZA Discussion Papers 622, Institute for the Study of Labor (IZA).
  17. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
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  19. Gilles Joseph & Thomas Weitzenblum, 2003. "Optimal Unemployment Insurance: Transitional Dynamics vs. Steady State," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 869-884, October.
  20. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  21. 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.
  22. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, Econometric Society, vol. 58(4), pages 757-82, July.
  23. Dale T. Mortensen, 1983. "A Welfare Analysis of Unemployment Insurance: Variations on Second Best Themes," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 549, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  24. Ana Fernandes & Christopher Phelan, 1999. "A recursive formulation for repeated agency with history dependence," Staff Report, Federal Reserve Bank of Minneapolis 259, Federal Reserve Bank of Minneapolis.
  25. Kenneth L. Judd & Sevin Yeltekin & James Conklin, 2003. "Computing Supergame Equilibria," Econometrica, Econometric Society, Econometric Society, vol. 71(4), pages 1239-1254, 07.
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Citations

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Cited by:
  1. Marcus Hagedorn & Ashok Kaul, 2004. "An Adverse Selection Model of Optimal Unemployment Insurance," 2004 Meeting Papers 331, Society for Economic Dynamics.
  2. Anne Bucher & Sébastien Ménard, 2010. "Employment Protection Legislation and Adverse Selection at the Labor Market Entry," Working Papers halshs-00812099, HAL.
  3. David Fuller, 2008. "Adverse Selection and Moral Hazard: Quanitative Implications for Unemployment Insurance," 2008 Meeting Papers 889, Society for Economic Dynamics.
  4. Jean-Olivier Hairault & François Langot & Sébastien Menard & Thepthida Sopraseuth, 2012. "Optimal Unemployment Insurance for Older Workers," TEPP Working Paper, TEPP 2012-07, TEPP.
  5. O'Flaherty, Brendan, 2009. "When should homeless families get subsidized apartments? A theoretical inquiry," Journal of Housing Economics, Elsevier, Elsevier, vol. 18(2), pages 69-80, June.
  6. Tobias Laun, 2012. "Optimal Social Insurance with Endogenous Health," 2012 Meeting Papers, Society for Economic Dynamics 438, Society for Economic Dynamics.
  7. Arpad Abraham & Nicola Pavoni, 2008. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending: A Recursive Formulation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 781-803, October.

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