Working Paper: CEPR ID: DP9864
Authors: Giuseppe Bertola; Winfried Koeniger
Abstract: We consider an economy where individuals privately choose effort and trade competitively priced securities that pay off with effort-determined probability. We show that if insurance against a negative shock is sufficiently incomplete, then standard functional form restrictions ensure that individual objective functions are optimized by an effort and insurance combination that is unique and satisfies first- and second-order conditions. Modeling insurance incompleteness in terms of costly production of private insurance services, we characterize the constrained inefficiency arising in general equilibrium from competitive pricing of non-exclusive financial contracts.
Keywords: Constrained Efficiency; First-Order Approach; Hidden Action; Principal-Agent
JEL Codes: D81; D82; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| hidden insurance and moral hazard (G52) | equilibrium existence (C62) |
| effort choices (D87) | insurance contracts (G22) |
| effort (D29) | probability of negative income shocks (D80) |
| probability of negative income shocks (D80) | pricing of insurance contracts (G22) |
| insurance contracts (G22) | individual consumption choices (D10) |
| incomplete insurance (G52) | constrained inefficiency in equilibrium (D59) |
| actuarially unfair insurance (G22) | equilibrium with positive effort (D50) |
| moral hazard problem (D82) | inefficiencies in equilibrium (D59) |
| taxation or public transfer schemes (H87) | address inefficiencies from moral hazard (D61) |