Adverse Selection, Private Information, and Lowballing in Insurance Markets
Recent contributions to the adverse selection literature have focused on a multiperiod competitive environment. In this setting a clean distinction arises between the predictions of competing models. Cooper and Hayes extend the model of Rothschild and Stiglitz to multiple periods. The result is a self-selecting equilibrium characterized by price highballing, or systematically overcharging new business. Kunreuther and Pauly suggest that information asymmetries between competing insurance firms render such price-quantity policies infeasible. Their model results in a pooling equilibrium that is characterized by price lowballing, or systematically undercharging new business. Our evidence is consistent with the Kunreuther and Pauly model and reveals the persistence of adverse selection in the automobile insurance market. Copyright 1990 by the University of Chicago.
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