To Insure or Not to Insure? Promoting Trust and Cooperation with Insurance Advice in Markets

Abstract

We design a novel insurance advice mechanism aimed at promoting trust and cooperation in markets with asymmetric information. In a buyer-seller game, sellers are given the option to advise buyers on whether to purchase third-party insurance against the potential losses from the opportunistic behavior of strategic sellers. The theoretical model suggests that both cooperative and strategic sellers will advise buyers not to purchase the insurance. Once this advice has been given, strategic sellers are less likely to pursue self-interest due to the associated psychological costs. We conduct a controlled laboratory experiment and show that the insurance advice mechanism significantly increases market efficiency, with sellers being more likely to cooperate with buyers and buyers being more likely to purchase from the seller. Furthermore, we find that the insurance advice mechanism is more effective when sellers can observe buyers’ insurance purchase decisions.

Keywords: asymmetric information, insurance, trust, cooperation, experimental economics

JEL Classification: C91, D9, D47, D82, L86