The Insurance is the Lemon: Failing to Index Contracts

44 Pages Posted: 15 Jan 2019 Last revised: 17 Jul 2021

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: January 2019

Abstract

We model the widespread failure of contracts to share risk using available indices. A borrower 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 (January 2019). NBER Working Paper No. w25450, Available at SSRN: https://ssrn.com/abstract=3315291

Barney Hartman-Glaser (Contact Author)

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

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

Benjamin M. Hebert

Stanford University ( email )

Stanford, CA 94305
United States

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