Ambiguity Aversion in Competitive Insurance Markets with Asymmetric Information

44 Pages Posted: 5 Apr 2019

See all articles by Richard Peter

Richard Peter

University of Iowa

Andreas Richter

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management)

Paul D. Thistle

University of Nevada, Las Vegas - Department of Finance

Date Written: March 10, 2019

Abstract

We analyze the effect of ambiguous loss probabilities on competitive insurance markets with asymmetric information. We characterize equilibria under actuarially fair pricing with preferences that are second-order ambiguity averse (have smooth indifference curves). We also show existence of uniqueness of the second-best contracts and provide a characterization. Non-increasing absolute ambiguity aversion is sufficient for adverse selection in the smooth model. We then determine the effect of ambiguity on equilibrium under ambiguity aversion. There is a coverage effect because ambiguity relaxes the self-selection constraint and raises the available coverage for the low risks, and an ambiguity effect because ambiguity makes ambiguity averse agents worse off. Both effects are conflicting when it comes to their impact on the critical pro-portion of high risks required for a Rothschild-Stiglitz equilibrium to exist and social welfare. We derive conditions that allow to resolve the indeterminate social welfare effect.

Keywords: adverse selection, ambiguity, efficiency, second best, uncertainty averse preferences, welfare

JEL Classification: D80, G22, C30

Suggested Citation

Peter, Richard and Richter, Andreas and Thistle, Paul D., Ambiguity Aversion in Competitive Insurance Markets with Asymmetric Information (March 10, 2019). Available at SSRN: https://ssrn.com/abstract=3351930 or http://dx.doi.org/10.2139/ssrn.3351930

Richard Peter (Contact Author)

University of Iowa ( email )

341 Schaeffer Hall
Iowa City, IA 52242-1097
United States

Andreas Richter

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management) ( email )

Schackstraße 4
Munich, 80539
Germany

Paul D. Thistle

University of Nevada, Las Vegas - Department of Finance ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States
702-895-3856 (Phone)
702-895-4650 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
18
Abstract Views
288
PlumX Metrics