Welfare-improving ambiguity in insurance markets with asymmetric information

TY - JOUR

T1 - Welfare-improving ambiguity in insurance markets with asymmetric information

AU - Koufopoulos, Konstantinos

AU - Kozhan, Roman

PY - 2014/5

Y1 - 2014/5

N2 - We consider a model of competitive insurance markets involving both asymmetric information and ambiguity about the accident probability. We show that there can exist a full-insurance pooling equilibrium. We also present an example where an increase in ambiguity leads to a strict Pareto improvement. Higher ambiguity relaxes high-risks’ incentive compatibility constraint and allows low risks to buy more insurance. Higher ambiguity also deteriorates low risks’ expected utility from holding an uncertain prospect. If the former effect dominates, the expected utility of low risks increases and given that high risks’ utility remains unaffected, the increase in ambiguity implies a strict Pareto improvement.

AB - We consider a model of competitive insurance markets involving both asymmetric information and ambiguity about the accident probability. We show that there can exist a full-insurance pooling equilibrium. We also present an example where an increase in ambiguity leads to a strict Pareto improvement. Higher ambiguity relaxes high-risks’ incentive compatibility constraint and allows low risks to buy more insurance. Higher ambiguity also deteriorates low risks’ expected utility from holding an uncertain prospect. If the former effect dominates, the expected utility of low risks increases and given that high risks’ utility remains unaffected, the increase in ambiguity implies a strict Pareto improvement.

KW - Ambiguity aversion

KW - Asymmetric information

KW - Welfare improvement

U2 - 10.1016/j.jet.2013.11.003

DO - 10.1016/j.jet.2013.11.003

M3 - Article

SN - 0022-0531

VL - 151

SP - 551

EP - 560

JO - Journal of Economic Theory

JF - Journal of Economic Theory

ER -