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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.

Suggested Citation

  • David Fuller, 2008. "Adverse Selection and Moral Hazard: Quanitative Implications for Unemployment Insurance," 2008 Meeting Papers 889, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:889

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    References listed on IDEAS

    1. 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.
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    More about this item

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings


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