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The Insurance is the Lemon: Failing to Index Contracts

Author

Listed:
  • Barney Hartman-Glaser

    (UCLA)

  • Benjamin Hebert

    (Stanford University)

Abstract

We model the widespread failure of contracts to share risk using available indices. A borrower and lender can share risk by conditioning repayments on an index. The lender has private information about the ability of this index to measure the true state the borrower would like to hedge. The lender is risk-averse, and thus requires a premium to insure the borrower. The borrower, however, might be paying something for nothing, if the index is a poor measure of the true state. We provide sufficient conditions for this effect to cause the borrower to choose a non-indexed contract instead.

Suggested Citation

  • Barney Hartman-Glaser & Benjamin Hebert, 2018. "The Insurance is the Lemon: Failing to Index Contracts," 2018 Meeting Papers 160, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:160
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    References listed on IDEAS

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    Cited by:

    1. Vida, Péter & Honryo, Takakazu, 2021. "Strategic stability of equilibria in multi-sender signaling games," Games and Economic Behavior, Elsevier, vol. 127(C), pages 102-112.
    2. Chaigneau, Pierre & Edmans, Alex & Gottlieb, Daniel, 2018. "Does improved information improve incentives?," Journal of Financial Economics, Elsevier, vol. 130(2), pages 291-307.
    3. repec:bin:bpeajo:v:49:y:2019:i:2018-01:p:429-513 is not listed on IDEAS
    4. Peter Vida & Takakazu Honryo & Helmuts Azacis, 2022. "Strong Forward Induction in Monotonic Multi-Sender Signaling Games," THEMA Working Papers 2022-08, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    5. Tomasz Piskorski & Amit Seru, 2018. "Mortgage Market Design: Lessons from the Great Recession," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 49(1 (Spring), pages 429-513.
    6. Cóndor Richard, 2020. "Shared-Appreciation Mortgages and Uninsurable Idiosyncratic Shocks," Working Papers 2020-11, Banco de México.
    7. Firoozi, Fathali & Lien, Donald, 2022. "Models of optimal contract in lending: Evaluating the impact of diversified versus focused policies on riskiness of borrower base," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
    8. Alexei Tchistyi, 2018. "An Equilibrium Model of Housing and Mortgage Markets with State-Contingent Lending Contracts," 2018 Meeting Papers 244, Society for Economic Dynamics.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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