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Adverse Selection and Moral Hazard: Quanitative Implications for Unemployment Insurance

Author

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  • David Fuller

    (University of Iowa)

Abstract

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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    Cited by:

    1. is not listed on IDEAS
    2. Cirelli, Fernando & Espino, Emilio & Sánchez, Juan M., 2021. "Designing unemployment insurance for developing countries," Journal of Development Economics, Elsevier, vol. 148(C).
    3. Imen Karaa, 2018. "Moral Hazard and Learning in the Tunisian Automobile Insurance Market: New Evidence from Dynamic Data," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 43(3), pages 560-589, July.
    4. Gürtler, Marc & Koch, Florian, 2021. "Multidimensional skin in the game," Journal of Mathematical Economics, Elsevier, vol. 97(C).
    5. Sergio Cappellini, 2022. "Optimal Unemployment Insurance with Worker Profiling," "Marco Fanno" Working Papers 0294, Dipartimento di Scienze Economiche "Marco Fanno".
    6. Noureddine Benlagha & Imen Karaa, 2017. "Evidence of adverse selection in automobile insurance market: A seemingly unrelated probit modelling," Cogent Economics & Finance, Taylor & Francis Journals, vol. 5(1), pages 1330303-133, January.
    7. 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.

    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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