Misperceptions and Contract Distortions in Insurance Markets

52 Pages Posted: 23 Feb 2021

See all articles by Adam Solomon

Adam Solomon

Massachusetts Institute of Technology (MIT) - Department of Economics

Date Written: February 17, 2021

Abstract

This paper extends the theory and empirics of selection markets to account for heterogenous
risk misperceptions and endogenous contracts. The literature has typically assumed zero or a
uniform bias across the population, and a fixed contract space. I first develop the theoretical
tools to analyze the equilibrium and welfare impact of risk misperceptions in a variety of market
structures and equilibrium concepts. The theory shows that a key statistic is the covariance
between risk and risk misperception in addition to the direction of misperception. Empirically, I
show that in mortality risk markets the long-lived are pessimistic, and the short-lived relatively
unbiased. I demonstrate the robustness of these findings to an accounting for elicitation error.
These results imply that the intensive margin, for example in annuity markets, is critically
important for welfare and particularly distorted with this pattern of misperception. The annuity
puzzle is clarified as an equilibrium distortion downwards of both the participation margin and
the insurance offered in the market.

Suggested Citation

Solomon, Adam, Misperceptions and Contract Distortions in Insurance Markets (February 17, 2021). Available at SSRN: https://ssrn.com/abstract=3787556 or http://dx.doi.org/10.2139/ssrn.3787556

Adam Solomon (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
E52-391
Cambridge, MA 02142
United States

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

Paper statistics

Downloads
2
Abstract Views
54
PlumX Metrics