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Welfare-improving ambiguity in insurance markets with asymmetric information

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JournalJournal of Economic Theory
DatePublished - May 2014
Volume151
Number of pages10
Pages (from-to)551 - 560
Original languageEnglish

Abstract

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.

    Research areas

  • Ambiguity aversion, Asymmetric information, Welfare improvement

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