DP9864 | Hidden Insurance in a Moral Hazard Economy

Publication Date

02/03/2014

JEL Code(s)

Keyword(s)

Programme Area(s)

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.