No. 2008/38
Hidden Regret in Insurance Markets:
Adverse and Advantageous Selection Rachel J. Huang, Alexander Muermann,
and Larry Y. Tzeng
Center for Financial Studies House of Finance Goethe-Universität Grüneburgplatz 1 60323 Frankfurt am Main Deutschland
Center for Financial Studies
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* We wish to thank seminar participants at the Wharton School Applied Economics workshop, the Risk Theory Society meeting 2007, and the EGRIE meeting 2007 for their valuable comments. Muermann gratefully acknowledges .nancial support of the National Institutes of Health - National Institute on Aging, Grant number P30 AG12836, the Boettner Center for Pensions and Retirement Security at the University of Pennsylvania, and National Institutes of Health .National Institute of Child Health and Development Population Research Infrastructure Program R24 HD-044964, all at the University of Pennsylvania.
1 Ming Chuan University, Finance Department, 250 Zhong Shan N. Rd., Sec. 5, Taipei 111, TAIWAN
2 corresponding author: Vienna University of Economics and Business Administration,Department of Finance and Accounting, and CFS Heiligenstaedter Str. 46-48, A-1190 Wien, AUSTRIA, email: alexander.muermann@wu-wien.ac.at
3 National Taiwan University, Finance Department, No. 1, Sec. 4, Roosevelt Road, Taipei, 10617, TAIWAN
CFS Working Paper No. 2008/38
Hidden Regret in Insurance Markets:
Adverse and Advantageous Selection*
Rachel J. Huang
1, Alexander Muermann
2, and Larry Y. Tzeng
3March, 2008
Abstract:
We examine insurance markets with two types of customers: those who regret suboptimal decisions and those who don.t. In this setting, we characterize the equilibria under hidden information about the type of customers and hidden action. We show that both pooling and separating equilibria can exist. Furthermore, there exist separating equilibria that predict a positive correlation between the amount of insurance coverage and risk type, as in the standard economic models of adverse selection, but there also exist separating equilibria that predict a negative correlation between the amount of insurance coverage and risk type, i.e.
advantageous selection. Since optimal choice of regretful customers depends on foregone alternatives, any equilibrium includes a contract which is o¤ered but not purchased.
JEL Classification: D03, D81, D82,
Keywords: Asymmetric Information, Regret, Insurance.
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:8FC6 )6A2C2E:?8 BF:=:3C:F> H:E9 25G2?E286@FD D6=64E:@? EJA6 :?5:G:5F2=D :?G6DE :? D6=7 AC@E64E:@? H96C62D EJA6:?5:G:5F2=D 5@ ?@E *JA6 :?5:G:5F2=D @3E2:? >@C6 :?DFC2?46 4@G6C286 E92? EJA6 :?5:G:5F2=D
*
EUN
N
450
PF
A WL
WNL
0 w
L w−
*
EUR
P0
P ΔN =0
R X
' N
:8FC6 )6A2C2E:?8 BF:=:3C:F> H:E9 25G6CD6 D6=64E:@? EJA6 :?5:G:5F2=D :?G6DE :? D6=7 AC@E64E:@? H96C62D EJA6:?5:G:5F2=D 5@ ?@E *JA6 :?5:G:5F2=D @3E2:? =6DD :?DFC2?46 4@G6C286 E92? EJA6 :?5:G:5F2=D
0 ) ( 1 = ΔN F
450
PF
A WL
WNL
) (F1
EUN
0 w
L w−
P0
P
*
EUR
0 ) ( 2 = ΔN F
0 ) ( 3 = ΔN F
) (F2
EUN
) (F3
EUN
:8FC6 @>A2C2E:G6 DE2E:4D H:E9 C6DA64E E@
R3
) ( 2
* k EUR
) ( 3
* k EUR
) ( 1
* k EUR
450
PF
A WL
WNL
0 w
L w−
P0
0
= ΔN
P
R2
R1
:8FC6 @>A2C2E:G6 DE2E:4D H:E9 C6DA64E E@ :?E6?D:EJ @7 C68C6E
