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An adverse selection model of optimal unemployment insurance

  • Hagedorn, Marcus
  • Kaul, Ashok
  • Mennel, Tim

We ask whether offering a menu of unemployment insurance contracts is welfare-improving in a heterogeneous population. We adopt a repeated moral hazard framework as in Shavell and Weiss (1979), supplemented by unobserved heterogeneity about agents' job opportunities. Our main theoretical contribution is a quasi-recursive formulation of our adverse selection problem, including a geometric characterization of the state space. Our main economic result is that optimal contracts for "bad" searchers tend to be upward-sloping due to an adverse selection effect. This is in contrast to the well-known optimal decreasing time profile of benefits in pure moral hazard environments that continue to be optimal for "good" searchers in our model.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 34 (2010)
Issue (Month): 3 (March)
Pages: 490-502

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Handle: RePEc:eee:dyncon:v:34:y:2010:i:3:p:490-502
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  19. 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).
  20. 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.
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