The Insurance Is the Lemon: Failing to Index Contracts

43 Pages Posted: 5 Oct 2017 Last revised: 9 Jun 2019

See all articles by Barney Hartman-Glaser

Barney Hartman-Glaser

University of California, Los Angeles (UCLA) - Anderson School of Management

Benjamin Hebert

Stanford University

Multiple version iconThere are 2 versions of this paper

Date Written: May 4, 2019

Abstract

We model the widespread failure of contracts to share risk using available indices. A bor- rower and lender can share risk by conditioning repayments on an index. The lender has private information about the ability of this index to measure the true state that the borrower would like to hedge. The lender is risk averse and thus requires a premium to insure the borrower. The borrower, however, might be paying something for nothing if the index is a poor measure of the true state. We provide sufficient conditions for this effect to cause the borrower to choose a non-indexed contract instead.

Suggested Citation

Hartman-Glaser, Barney and Hebert, Benjamin M., The Insurance Is the Lemon: Failing to Index Contracts (May 4, 2019). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3048100 or http://dx.doi.org/10.2139/ssrn.3048100

Barney Hartman-Glaser

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Benjamin M. Hebert (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

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