Optimal Insurance Under Adverse Selection and Ambiguity Aversion

Abstract

We consider a model of competitive insurance markets under asymmetric information with ambiguity-averse agents who maximize their maxmin expected utility. The interaction between asymmetric information and ambiguity aversion gives rise to some interesting results. First, for some parameter values, there exists a unique pooling equilibrium where both types of insurees buy full insurance. Second, in separating equilibria where the low risks are underinsured their equilibrium contract involves more coverage than under standard expected utility. Due to the endogeneity of commitment to the contracts offered by insurers, our model has always an equilibrium which is unique and interim incentive efficient (second-best).

Keywords: Adverse Selection, Ambiguity Aversion, Endogenous Commitment

JEL Classification: D82, G22