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Dynamic Optimal Insurance and Lack of Commitment

Author

Listed:
  • Alexander Karaivanov

    (Simon Fraser University)

  • Fernando Martin

    (Federal Reserve Bank of St. Louis)

Abstract

We analyze dynamic risk-sharing contracts between profit-maximizing insurers and risk-averse agents who face idiosyncratic income uncertainty and can self-insure through savings. We study Markov-perfect insurance contracts in which neither party can commit beyond the current period. We show that the limited commitment assumption on the insurer's side is restrictive only when he is endowed with a rate of return advantage and the agent has sufficiently large initial assets. In such a case, the agent's consumption profile is distorted relative to the first-best. In a Markov-perfect equilibrium, the agent's asset holdings determine his outside option each period and are thus an integral part of insurance contracts, unlike when the insurer can commit long-term. (Copyright: Elsevier)

Suggested Citation

  • Alexander Karaivanov & Fernando Martin, 2015. "Dynamic Optimal Insurance and Lack of Commitment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 287-305, April.
  • Handle: RePEc:red:issued:10-93
    DOI: 10.1016/j.red.2014.05.001
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Oikonomou, Rigas, 2013. "Optimal Unemployment Insurance with Private Insurance," MPRA Paper 55726, University Library of Munich, Germany.
    2. Karaivanov, Alexander K. & Martin, Fernando M., 2011. "Markov-Perfect Risk Sharing, Moral Hazard and Limited Commitment," Working Papers 2011-030, Federal Reserve Bank of St. Louis, revised 11 Sep 2017.
    3. Karaivanov, Alexander K. & Martin, Fernando M., 2016. "Market Power and Asset Contractibility in Dynamic Insurance Contracts," Review, Federal Reserve Bank of St. Louis, vol. 98(2), pages 111-127.

    More about this item

    Keywords

    Optimal insurance; Lack of commitment; Markov-perfect equilibrium;

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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