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An Adverse Selection Model of Optimal Unemployment Insurance

  • Marcus Hagedorn
  • Ashok Kaul

We derive the shape of optimal unemployment insurance contracts when agents can exert search effort but have private information about their search technology. We derive a recursive solution of our adverse selection problem with repeated moral hazard. Conditions under which the UI agency should always offer separating contracts are identified. We show that the good searcher receives the minimal entitlement. Our main theoretical contribution is a numerically useful analytical characterization of the sets of jointly feasible entitlements. This allows us to map our analytical results one-to-one to a numerical algorithm. According to our results the contract for the good searcher has a decreasing benefit profile, as the one he would be offered in a pure moral hazard environment. In contrast, the contract of the bad searcher is distorted by an adverse selection effect, so that it tends to have an upward-sloping benefit profile. We provide a comparative static analysis of changes in various parameters of our model

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 331.

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Date of creation: 2004
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Handle: RePEc:red:sed004:331
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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