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Adverse Selection, Commitment, and Renegotiation: Extension to and Evidence from Insurance Markets

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  • Dionne, Georges
  • Doherty, Neil A

Abstract

With asymmetric information, full commitment to long-term contracts may permit markets to approach first-best allocations. However, commitment can be undermined by opportunistic behavior, notably renegotiation. The authors reexamine commitment in insurance markets. They present an alternative model (which extends Jean-Jaques Laffont and Jean Tirole's procurement model to address uncertainty and competition), which involves semipooling in the first period followed by separation. This and competing models (e.g., single-period models and no-commitment models) have different predictions concerning temporal patterns of insurer profitability. A test using California data suggests that some automobile insurers use commitment to attract selective portfolios comprising disproportionate numbers of low risks. Copyright 1994 by University of Chicago Press.

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  • Dionne, Georges & Doherty, Neil A, 1994. "Adverse Selection, Commitment, and Renegotiation: Extension to and Evidence from Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 209-235, April.
    • Handle: RePEc:ucp:jpolec:v:102:y:1994:i:2:p:209-35
    DOI: 10.1086/261929
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    References listed on IDEAS

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    1. Georges Dionne & Pierre Lasserre, 1985. "Adverse Selection, Repeated Insurance Contracts and Announcement Strategy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 719-723.
    2. Jack Hirschleifer & John G. Riley, 1979. "Uncertainty and Information in Economics," UCLA Economics Working Papers 140, UCLA Department of Economics.
    3. Paul Beaudry & Michel Poitevin, 1995. "Competitive Screening in Financial Markets when Borrowers can Recontract," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 62(3), pages 401-423.
    4. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-359, March.
    5. Mathias Dewatripont, 1989. "Renegotiation and Information Revelation Over Time: The Case of Optimal Labor Contracts," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(3), pages 589-619.
    6. Dionne, G. & Lasserre, P., 1983. "Adverse Selection and Repeated Insurance Contracts: Finite and Infinite Horizons," Cahiers de recherche 8326, Universite de Montreal, Departement de sciences economiques.
    7. Samuel Gal & Michael Landsberger, 1988. "On "Small Sample" Properties of Experience Rating Insurance Contracts," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 103(1), pages 233-243.
    8. Bolton, Patrick, 1990. "Renegotiation and the dynamics of contract design," European Economic Review, Elsevier, vol. 34(2-3), pages 303-310, May.
    9. Dionne, Georges & Doherty, Neil A, 1994. "Adverse Selection, Commitment, and Renegotiation: Extension to and Evidence from Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 209-235, April.
    10. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 629-649.
    11. D'Arcy, Stephen P & Doherty, Neil A, 1990. "Adverse Selection, Private Information, and Lowballing in Insurance Markets," The Journal of Business, University of Chicago Press, vol. 63(2), pages 145-164, April.
    12. Kunreuther, Howard & Pauly, Mark, 1985. "Market equilibrium with private knowledge : An insurance example," Journal of Public Economics, Elsevier, vol. 26(3), pages 269-288, April.
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