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Dynamic Optimal Insurance and Lack of Commitment

We analyze the role of commitment in a dynamic principal-agent model of optimal insurance with hidden effort and observable but non-contractible savings. We argue that the optimal contract under full commitment is time-inconsistent. Consequently, we analyze the optimal time-consistent Markov-perfect insurance contract when both the agent and the principal cannot commit for longer than one period and contrast our results with the full commitment case from the existing literature. We find that the optimal contract under lack of commitment provides additional insurance relative to the autarky allocation and features non-degenerate long-run asset and consumption distributions. Furthermore, the no-commitment contract differs significantly from the commitment contract in the time profiles of consumption, savings, and welfare. We solve for the optimal insurance contracts in several environments featuring different degrees of market incompleteness and find that the welfare loss due to lack of commitment can be very high relative to the welfare costs of moral hazard or savings non-contractibility.

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File URL: http://www.sfu.ca/econ-research/RePEc/sfu/sfudps/dp07-22.pdf
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Paper provided by Department of Economics, Simon Fraser University in its series Discussion Papers with number dp07-22.

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Length: 37
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:sfu:sfudps:dp07-22
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  1. Helmut Bester & Roland Strausz, . "Imperfect Commitment and the Revelation Principle," Papers 004, Departmental Working Papers.
  2. Natalia Kovrijnykh, 2013. "Debt Contracts with Partial Commitment," American Economic Review, American Economic Association, vol. 103(7), pages 2848-74, December.
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  6. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
  7. Abraham, Arpad & Pavoni, Nicola, 2004. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending," Working Papers 04-05, Duke University, Department of Economics.
  8. Alexander K. Karaivanov & Fernando M. Martin, 2011. "Moral hazard and lack of commitment in dynamic economies," Working Papers 2011-030, Federal Reserve Bank of St. Louis.
  9. Kalai, Ehud, 1977. "Proportional Solutions to Bargaining Situations: Interpersonal Utility Comparisons," Econometrica, Econometric Society, vol. 45(7), pages 1623-30, October.
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  11. Bester, Helmut & Strausz, Roland, 2001. "Contracting with Imperfect Commitment and the Revelation Principle: The Single Agent Case," Econometrica, Econometric Society, vol. 69(4), pages 1077-98, July.
  12. Dirk Krueger & Harald Uhlig, 2003. "Competitive Risk Sharing Contracts with One-Sided Commitment," NBER Working Papers 10135, National Bureau of Economic Research, Inc.
  13. Matthias Doepke & Robert M. Townsend, 2002. "Dynamic Mechanism Design With Hidden Income and Hidden Actions," UCLA Economics Working Papers 818, UCLA Department of Economics.
  14. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
  15. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
  16. 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.
  17. Christopher Sleet & Sevin Yeltekin, 2006. "Credibility and endogenous societal discounting," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(3), pages 410-437, July.
  18. Harold L. Cole & Narayana R. Kocherlakota, 1999. "Efficient allocations with hidden income and hidden storage," Staff Report 238, Federal Reserve Bank of Minneapolis.
  19. Bisin, Alberto & Rampini, Adriano A., 2006. "Markets as beneficial constraints on the government," Journal of Public Economics, Elsevier, vol. 90(4-5), pages 601-629, May.
  20. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31.
  21. Jonathan Thomas & Tim Worrall, 1988. "Self-Enforcing Wage Contracts," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 541-554.
  22. Daron Acemoglu & Mikhail Golosov & Aleh Tsyvinski, 2007. "Political Economy of Mechanisms," Levine's Bibliography 321307000000000886, UCLA Department of Economics.
  23. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  24. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 209-244.
  25. Eric Maskin & Jean Tirole, 1997. "Markov Perfect Equilibrium, I: Observable Actions," Harvard Institute of Economic Research Working Papers 1799, Harvard - Institute of Economic Research.
  26. Sleet, Christopher & Yeltekin, Sevin, 2008. "Politically credible social insurance," Journal of Monetary Economics, Elsevier, vol. 55(1), pages 129-151, January.
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