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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. Narayana Kocherlakota, 2004. "Figuring out the Impact of Hidden Savings on Optimal Unemployment Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 541-554, July.
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  9. repec:spo:wpecon:info:hdl:2441/8921 is not listed on IDEAS
  10. Hagedorn, Marcus & Kaul, Ashok & Mennel, Tim, 2002. "An adverse selection model of optimal unemployment insurance," ZEI Working Papers B 30-2002, University of Bonn, ZEI - Center for European Integration Studies.
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  19. Rebecca M. Blank & David Card, 1989. "Recent Trends in Insured and Uninsured Unemployment: Is There an Explanation?," NBER Working Papers 2871, National Bureau of Economic Research, Inc.
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  23. 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.
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  25. Pries, Michael & Rogerson, Richard, 2009. "Search frictions and labor market participation," European Economic Review, Elsevier, vol. 53(5), pages 568-587, July.
  26. Pavoni, Nicola, 2007. "On optimal unemployment compensation," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1612-1630, September.
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