Asymmetric information, heterogeneity in risk perceptions and insurance: an explanation to a puzzle
Given that, in equilibrium, all agents freely opt for strictly positive own coverage, competitive models of asymmetric information predict a positive relationship between coverage and ex post risk (accident probability). On the other hand, some recent empirical studies find either negative or no correlation. This paper, by introducing heterogeneity in risk perceptions into an asymmetric information competitive model, provides an explanation to this puzzle. The more optimistic agents underestimate their accident probability relative to less optimistic and so purchase less insurance. They also tend to be less willing to take precautions. This gives rise to separating equilibria exhibiting negative or no correlation between coverage and ex post risk that potentially explain the puzzling empirical findings. Moreover, the no-correlation equilibrium involves some agents being quantity-constrained due to adverse selection. Thus, although the no-correlation empirical findings indicate that there may not be risk-related adverse selection, they do not imply the absence of other forms of adverse selection that have significant effects on the resulting equilibrium.
|Date of creation:||Feb 2002|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +44 (020) 7405 7686
Web page: http://www.lse.ac.uk/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Tomas Philipson & John Cawley, 1999.
"An Empirical Examination of Information Barriers to Trade in Insurance,"
American Economic Review,
American Economic Association, vol. 89(4), pages 827-846, September.
- John Cawley & Tomas Philipson, 1997. "An Empirical Examination of Information Barriers to Trade inInsurance," University of Chicago - George G. Stigler Center for Study of Economy and State 132, Chicago - Center for Study of Economy and State.
- John Cawley & Tomas Philipson, 1996. "An Empirical Examination of Information Barriers to Trade in Insurance," NBER Working Papers 5669, National Bureau of Economic Research, Inc.
- Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
- Villeneuve, Bertrand, 2000.
"The consequences for a monopolistic insurance firm of evaluating risk better than customers : The adverse selection hypothesis reversed,"
Economics Papers from University Paris Dauphine
123456789/5367, Paris Dauphine University.
- Bertrand Villeneuve, 2000. "The Consequences for a Monopolistic Insurance Firm of Evaluating Risk Better than Customers: The Adverse Selection Hypothesis Reversed," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 25(1), pages 65-79, June.
- de Meza, David & Webb, David C, 2001.
"Advantageous Selection in Insurance Markets,"
RAND Journal of Economics,
The RAND Corporation, vol. 32(2), pages 249-62, Summer.
- Richard J. Arnott & Joseph E. Stiglitz, 1988.
"The Basic Analytics of Moral Hazard,"
NBER Working Papers
2484, National Bureau of Economic Research, Inc.
- Manove, Michael & Padilla, Atilano Jorge, 1998.
"Banking (Conservatively) With Optimists,"
CEPR Discussion Papers
1918, C.E.P.R. Discussion Papers.
- Georges Dionne & Christian Gourieroux & Charles Vanasse, 2001. "Testing for Evidence of Adverse Selection in the Automobile Insurance Market: A Comment," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 444-473, April.
- Chassagnon, A. & Chiappori, P.A., 1994. "Insurance Under Moral Hazard and Adverse Selection: The Case of Pure Competition," Papers 28, Laval - Laboratoire Econometrie.
- Brugiavini, Agar, 1993. "Uncertainty resolution and the timing of annuity purchases," Journal of Public Economics, Elsevier, vol. 50(1), pages 31-62, January.
- Viscusi, W Kip, 1990. "Do Smokers Underestimate Risks?," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1253-69, December.
When requesting a correction, please mention this item's handle: RePEc:ehl:lserod:24906. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (LSERO Manager)
If references are entirely missing, you can add them using this form.