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Adverse Selection and Moral Hazard: Quantitative Implications for Unemployment Insurance

I construct a dynamic contracting model of optimal unemployment insurance with adverse selection and moral hazard that captures the transition from unemployment to non-participation observed in the data, which the standard moral hazard model fails to capture. My model generates both qualitative and quantitative implications for the optimal provision of unemployment insurance. Qualitatively, for some agents, incentives in the optimal contract imply consumption increases over the duration of non-employment. Quantitatively, I compare the current U.S. system to the optimal one, and find large cost savings to adopting the optimal contract. The optimal contract achieves an additional 46% of cost savings relative to a planner who ignores adverse selection and focuses only on moral hazard. I also find the current transition from unemployment to non-participation to be efficient, and when compared to the current U.S. system, the optimal contract implies agents experiencing a long spell of non-participation have consumption increasing over the spell.

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Paper provided by Concordia University, Department of Economics in its series Working Papers with number 12004.

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Length: 52 pages
Date of creation: Aug 2010
Date of revision: Sep 2011
Handle: RePEc:crd:wpaper:12004
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  1. Pietro Garibaldi & Etienne Wasmer, 2005. "Equilibrium Search Unemployment, Endogenous Participation and Labor Market Flows," Sciences Po publications info:hdl:2441/8921, Sciences Po.
  2. Robert Shimer & Iván Werning, 2006. "On the Optimal Timing of Benefits with Heterogeneous Workers and Human Capital Depreciation," NBER Working Papers 12230, National Bureau of Economic Research, Inc.
  3. Hugo A. Hopenhayn & Juan Pablo Nicolini, 2009. "Optimal Unemployment Insurance and Employment History," Review of Economic Studies, Oxford University Press, vol. 76(3), pages 1049-1070.
  4. David Fuller & Stephane Auray & Damba Lkhagvasuren, 2013. "Unemployment Insurance Take-up Rates in an Equilibrium Search Model," Working Papers 13001, Concordia University, Department of Economics.
  5. Werning, Ivan & Farhi, Emmanuel, 2007. "Inequality and Social Discounting," Scholarly Articles 3451391, Harvard University Department of Economics.
  6. Mitchell, Matthew & Zhang, Yuzhe, 2010. "Unemployment Insurance with Hidden Savings," MPRA Paper 23214, University Library of Munich, Germany.
  7. Hopenhayn, H. & Nicolini, P.J., 1996. "Optimal Unemployment Insurance," RCER Working Papers 421, University of Rochester - Center for Economic Research (RCER).
  8. Hagedorn, Marcus & Kaul, Ashok & Mennel, Tim, 2002. "An adverse selection model of optimal unemployment insurance," ZEI Working Papers B 30-2002, ZEI - Center for European Integration Studies, University of Bonn.
  9. Nicola Pavoni, 2009. "Optimal Unemployment Insurance, With Human Capital Depreciation, And Duration Dependence," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(2), pages 323-362, 05.
  10. Gautier, Pieter A & Moraga-González, José-Luis & Wolthoff, Ronald, 2007. "Structural Estimation of Search Intensity: Do Non-Employed Workers Search Enough?," CEPR Discussion Papers 6440, C.E.P.R. Discussion Papers.
  11. Pries, Michael & Rogerson, Richard, 2009. "Search frictions and labor market participation," European Economic Review, Elsevier, vol. 53(5), pages 568-587, July.
  12. Wang, Cheng & Williamson, Stephen D., 2002. "Moral hazard, optimal unemployment insurance, and experience rating," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1337-1371, October.
  13. Rebecca Blank & David Card & Whitney Newey, 1988. "Recent Trends in Insured and Uninsured Unemployment: Is There an Explanation?," Working Papers 623, Princeton University, Department of Economics, Industrial Relations Section..
  14. Robert E. Hall & Paul R. Milgrom, 2008. "The Limited Influence of Unemployment on the Wage Bargain," American Economic Review, American Economic Association, vol. 98(4), pages 1653-74, September.
  15. Bruce D. Meyer, 1988. "Unemployment Insurance And Unemployment Spells," NBER Working Papers 2546, National Bureau of Economic Research, Inc.
  16. Narayana Kocherlakota, 2010. "Figuring out the impact of hidden savings on optimal unemployment insuranc," Levine's Working Paper Archive 506439000000000291, David K. Levine.
  17. Stéphane Auray & David L. Fuller & damba Lkhagvasuren, 2013. "Unemployment Insurance Take-up Rate"s in an Equilibrium Search Model," Working Papers 2013-12, Centre de Recherche en Economie et Statistique.
  18. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 427-53, July.
  19. Shavell, Steven & Weiss, Laurence, 1979. "The Optimal Payment of Unemployment Insurance Benefits over Time," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1347-62, December.
  20. Carl Davidson & Stephen A. Woodbury, 1997. "The Optimal Dole with Risk Aversion, Job Destruction, and Worker Heterogeneity," Upjohn Working Papers and Journal Articles 97-47, W.E. Upjohn Institute for Employment Research.
  21. Robert Shimer & Ivan Werning, 2005. "Liquidity and Insurance for the Unemployed," NBER Working Papers 11689, National Bureau of Economic Research, Inc.
  22. Pavoni, Nicola, 2007. "On optimal unemployment compensation," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1612-1630, September.
  23. Robert Shimer, 2012. "Reassessing the Ins and Outs of Unemployment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 127-148, April.
  24. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
  25. Yuzhe Zhang & Matthew Mitchell, 2007. "Optimal Unemployment Insurance with Hidden Trade," 2007 Meeting Papers 1023, Society for Economic Dynamics.
  26. Bryan Engelhardt & David L. Fuller, 2009. "Efficient Labor Force Participation with Search and Bargaining," Working Papers 0909, College of the Holy Cross, Department of Economics, revised Nov 2009.
  27. repec:spo:wpecon:info:hdl:2441/8921 is not listed on IDEAS
  28. Andolfatto, David & Gomme, Paul, 1996. "Unemployment insurance and labor-market activity in Canada," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 44(1), pages 47-82, June.
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