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Optimal insurance for time-inconsistent agents

Author

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  • Cherbonnier, Frédéric

Abstract

We examine the provision of insurance against non-observable liquidity shocks for time-inconsistent agents who can privately store resources. When lack of self-control is strong enough, optimal contracts are similar to individual nancial accounts with remunerated savings and costly borrowing. The corresponding rate of return decreases with savings, which gives a theoretical rationale for pension accounts with decreasing incentive schemes, as implemented in most developed countries. Extending the model to an innite horizon, we show that, in the presence of repeated shocks, optimal contracts lead to impoverishment almost surely. Usury laws, capping interest rates, worsen this tendency to over-indebtedness for consumers with low risk aversion. By contrast, hidden storage constrains resource allocation for time-consistent agents, so that optimal contracts induce them to accumulate wealth. Those results show how lack of self-control changes the nature of optimal savings and borrowing instruments, with normative implications in terms of tax policy and credit regulation.

Suggested Citation

  • Cherbonnier, Frédéric, 2021. "Optimal insurance for time-inconsistent agents," TSE Working Papers 21-1256, Toulouse School of Economics (TSE).
  • Handle: RePEc:tse:wpaper:126131
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    More about this item

    Keywords

    Time-inconsistency; self-control; mechanism design; insurance; over-indebtedness; retirement savings; consumer credit; credit regulation; saving incentives;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D73 - Microeconomics - - Analysis of Collective Decision-Making - - - Bureaucracy; Administrative Processes in Public Organizations; Corruption
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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