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A Dynamic Model of Health Plan Choice from a Real Options Perspective


  • Bhaswati Sengupta


  • Rachel Kreier


This paper develops a dynamic framework for analyzing an individual’s choice between a Preferred Provider Organization (PPO) and a Health Maintenance Organization (HMO) under uncertainty regarding future health. We explicitly model health as a stochastic process whose fluctuations arise from three sources, one deterministic and two stochastic. Health evolves over time with a downward drift over the lifespan. In addition, health is subject to small, mean zero random fluctuations. Finally, there exists a small possibility every period of a serious illness resulting in a large, discrete fall in health. Under this characterization of health uncertainty, we develop a Real Options model valuing flexibility in health plan choice which takes into account the embedded flexibility to receive coverage for out-of-network care if the PPO health plan is chosen. Our model suggests that greater health problems increase the value of the option to go out of network for the PPO enrollee. Copyright International Atlantic Economic Society 2011

Suggested Citation

  • Bhaswati Sengupta & Rachel Kreier, 2011. "A Dynamic Model of Health Plan Choice from a Real Options Perspective," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 39(4), pages 401-419, December.
  • Handle: RePEc:kap:atlecj:v:39:y:2011:i:4:p:401-419
    DOI: 10.1007/s11293-011-9287-x

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    References listed on IDEAS

    1. Capps, Cory & Dranove, David & Satterthwaite, Mark, 2003. " Competition and Market Power in Option Demand Markets," RAND Journal of Economics, The RAND Corporation, vol. 34(4), pages 737-763, Winter.
    2. Strombom, Bruce A. & Buchmueller, Thomas C. & Feldstein, Paul J., 2002. "Switching costs, price sensitivity and health plan choice," Journal of Health Economics, Elsevier, vol. 21(1), pages 89-116, January.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-638, June.
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    Cited by:

    1. Rachel Kreier & Bhaswati Sengupta, 2015. "Income, Health, and the Value of Preserving Options," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 43(4), pages 431-448, December.

    More about this item


    Real options; Health plan choice; Preferred provider organization; Provider quality; Managed competition; I11;

    JEL classification:

    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets


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