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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," Post-Print hal-01020784, HAL.
  2. Marcus Hagedorn & Ashok Kaul, 2004. "An Adverse Selection Model of Optimal Unemployment Insurance," 2004 Meeting Papers 331, Society for Economic Dynamics.
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  8. Emmanuel Farhi & Iván Werning, 2007. "Inequality and Social Discounting," Journal of Political Economy, University of Chicago Press, vol. 115, pages 365-402.
  9. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, vol. 58(4), pages 757-82, July.
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  13. 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.
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  15. 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.
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  19. repec:spo:wpecon:info:hdl:2441/8921 is not listed on IDEAS
  20. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-38, April.
  21. 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.
  22. Pieter A. Gautier & Jose Luis Moraga-Gonzalez & Ronald P. Wolthoff, 2007. "Structural Estimation of Search Intensity: Do Non-Employed Workers Search Enough?," Tinbergen Institute Discussion Papers 07-071/3, Tinbergen Institute.
  23. Pavoni, Nicola, 2007. "On optimal unemployment compensation," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1612-1630, September.
  24. 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.
  25. 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.
  26. Narayana Kocherlakota, 2010. "Figuring out the impact of hidden savings on optimal unemployment insuranc," Levine's Working Paper Archive 506439000000000291, David K. Levine.
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