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Adverse Selection and Moral Hazard: Quanitative Implications for Unemployment Insurance

  • David Fuller

    (University of Iowa)

I construct a dynamic contracting model of optimal unemployment insurance with adverse selection and moral hazard. The interaction of the two informational frictions generates novel qualitative and quantitative implications for the provision of unemployment insurance. Qualitatively, for certain agents, incentives in the optimal contract imply expected consumption may actually increase over the duration of unemployment. Quantitatively, the optimal contract reduces costs by over 100%, relative to a stylized version of the current U.S. unemployment insurance system. Compared to a planner who ignores adverse selection and focuses only on moral hazard, the optimal contract achieves an additional 47% of cost savings. Of the extra savings, around 3.2% arises from improved incentives to exert effort, leading to higher expected output. A more efficient allocation of consumption explains the remaining portion of the additional cost savings.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 889.

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Date of creation: 2008
Date of revision:
Handle: RePEc:red:sed008:889
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. Marcus Hagedorn & Ashok Kaul & Tim Mennel, 2007. "An Adverse Selection Model of Optimal Unemployment Insurance," IEW - Working Papers 315, Institute for Empirical Research in Economics - University of Zurich.
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  8. Pries, Michael & Rogerson, Richard, 2009. "Search frictions and labor market participation," European Economic Review, Elsevier, vol. 53(5), pages 568-587, July.
  9. Blank, Rebecca M & Card, David E, 1991. "Recent Trends in Insured and Uninsured Unemployment: Is There an Explanation?," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1157-89, November.
  10. repec:spo:wpecon:info:hdl:2441/8921 is not listed on IDEAS
  11. Stéphane Auray & David L. Fuller & damba Lkhagvasuren, 2013. "Unemployment Insurance Take-up Rate"s in an Equilibrium Search Model," Working Papers 2013-12, Centre de Recherche en Economie et Statistique.
  12. Mitchell, Matthew & Zhang, Yuzhe, 2010. "Unemployment Insurance with Hidden Savings," MPRA Paper 23214, University Library of Munich, Germany.
  13. Nicola Pavoni, 2009. "Optimal Unemployment Insurance, With Human Capital Depreciation, And Duration Dependence," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(2), pages 323-362, 05.
  14. Gautier, Pieter A. & Moraga-González, José L. & Wolthoff, Ronald P., 2007. "Structural Estimation of Search Intensity: Do Non-Employed Workers Search Enough?," IZA Discussion Papers 3045, Institute for the Study of Labor (IZA).
  15. Bruce D. Meyer, 1988. "Unemployment Insurance And Unemployment Spells," NBER Working Papers 2546, National Bureau of Economic Research, Inc.
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  17. Emmanuel Farhi & Iván Werning, 2007. "Inequality and Social Discounting," Journal of Political Economy, University of Chicago Press, vol. 115, pages 365-402.
  18. Narayana Kocherlakota, 2010. "Figuring out the impact of hidden savings on optimal unemployment insuranc," Levine's Working Paper Archive 506439000000000291, David K. Levine.
  19. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 427-53, July.
  20. Williamson, Stephen D. & Wang, Cheng, 1999. "Moral Hazard, Optimal Unemployment Insurance, and Experience Rating," Working Papers 99-03, University of Iowa, Department of Economics.
  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. 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.
  23. Steven Shavell & Laurence Weiss, 1978. "The Optimal Payment of Unemployment Insurance Benefits over Time," Cowles Foundation Discussion Papers 503, Cowles Foundation for Research in Economics, Yale University.
  24. Pietro Garibaldi & Etienne Wasmer, 2005. "Equilibrium Search Unemployment, Endogenous Participation and Labor Market Flows," Post-Print hal-01020784, HAL.
  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. Robert Shimer & Iván Werning, 2006. "On the Optimal Timing of Benefits with Heterogeneous Workers and Human Capital Depreciation," NBER Working Papers 12230, National Bureau of Economic Research, Inc.
  27. 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.
  28. Pavoni, Nicola, 2007. "On optimal unemployment compensation," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1612-1630, September.
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