Hidden overconfidence and advantageous selection
Journal
GENEVA Risk and Insurance Review
Journal Volume
35
Journal Issue
2
Pages
93-107
Date Issued
2010
Author(s)
Abstract
Theories of adverse selection and moral hazard predict the occurrence of the risk and the coverage of the insurance should be positively correlated, whereas empirical researches find little support of it. This paper provides a theoretical model of hidden overconfidence and demonstrates that a competitive insurance market may settle on separating equilibrium with advantageous selection predicting a negative relationship between risk and coverage. By assuming heterogeneity in risk perception and hidden action on self-protection, we find that, in equilibrium, the rational type of individual takes precautions to reduce the loss probability, whereas the overconfident type of individual will not make any effort. In the separating equilibrium, the insurer provides a product with high coverage to attract rational type of individual (low risk), and a product with low coverage for overconfident type of individual (high risk). In addition, other types of equilibrium such as adverse selection or linear premium rate are also found. ? 2010 The International Association for the Study of Insurance Economics.
Subjects
advantageous selection
adverse selection
asymmetric information
insurance market
moral hazard
overconfidence
Type
journal article
File(s)![Thumbnail Image]()
Loading...
Name
Huang2010_Article_HiddenOverconfidenceAndAdvanta.pdf
Size
240.27 KB
Format
Adobe PDF
Checksum
(MD5):069c844440341f8e99653c2fffd7336c