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An Adverse Selection Model of Optimal Unemployment Insurance

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  • Marcus Hagedorn
  • Ashok Kaul

Abstract

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

Suggested Citation

  • Marcus Hagedorn & Ashok Kaul, 2004. "An Adverse Selection Model of Optimal Unemployment Insurance," 2004 Meeting Papers 331, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:331
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    References listed on IDEAS

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    Cited by:

    1. Andreas Pollak, 2008. "Optimal Unemployment Insurance with Variable Skill Levels," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 164(4), pages 696-726, December.
    2. O'Flaherty, Brendan, 2009. "When should homeless families get subsidized apartments? A theoretical inquiry," Journal of Housing Economics, Elsevier, vol. 18(2), pages 69-80, June.
    3. Fehr, Ernst & Fischbacher, Urs & Kosfeld, Michael, 2005. "Neuroeconomic Foundations of Trust and Social Preferences," IZA Discussion Papers 1641, Institute of Labor Economics (IZA).
    4. Anne Bucher & Sébastien Ménard, 2010. "Employment Protection Legislation and Adverse Selection at the Labor Market Entry," TEPP Working Paper 2010-21, TEPP.
    5. 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.
    6. Tania Singer & Ernst Fehr, 2005. "The Neuroeconomics of Mind Reading and Empathy," American Economic Review, American Economic Association, vol. 95(2), pages 340-345, May.
    7. Tobias Laun, 2020. "Optimal Social Insurance with Endogenous Health," Scandinavian Journal of Economics, Wiley Blackwell, vol. 122(2), pages 464-493, April.
    8. Hagedorn, Marcus & Kaul, Ashok & Mennel, Tim, 2010. "An adverse selection model of optimal unemployment insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 490-502, March.
    9. Anne Bucher & Sébastien Ménard, 2015. "The effects of firing costs on the wage contracts under adverse selection," Working Papers of BETA 2015-17, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    10. Fuller, David L., 2014. "Adverse selection and moral hazard: Quantitative implications for unemployment insurance," Journal of Monetary Economics, Elsevier, vol. 62(C), pages 108-122.
    11. Hairault, Jean-Olivier & Langot, François & Ménard, Sébastien & Sopraseuth, Thepthida, 2012. "Optimal unemployment insurance for older workers," Journal of Public Economics, Elsevier, vol. 96(5), pages 509-519.
    12. Sergio Cappellini, 2022. "Optimal Unemployment Insurance with Worker Profiling," "Marco Fanno" Working Papers 0294, Dipartimento di Scienze Economiche "Marco Fanno".
    13. Armin Falk & Ernst Fehr & Christian Zehnder, "undated". "The Behavioral Effects of Minimum Wages," IEW - Working Papers 247, Institute for Empirical Research in Economics - University of Zurich.
    14. Temel Taskin, 2010. "Unemployment Insurance and Home Production," 2010 Meeting Papers 93, Society for Economic Dynamics.
    15. Arpad Abraham & Nicola Pavoni, 2008. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending: A Recursive Formulation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 781-803, October.

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    More about this item

    Keywords

    Unemployment Insurance; Adverse Selection; Repeated Moral Hazard;
    All these keywords.

    JEL classification:

    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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