Research Seminars & Workshops @ IRES
Professor Fang Hanming
Department of Economics, University of Pennsylvania
Multidimensional Private Information, Market Structure and Insurance Market
A large empirical literature has found that the correlation between insurance purchase and ex post realization of risk is often statistically insignificant or negative, which is inconsistent with the predictions from the classic models of insurance a la Akerlof (1972), Pauly (1974) and Rothschild and Stiglitz (1976), where consumers differ only in their risk types. It is suggested that the selection based on multidimensional private information, e.g., risk type and risk preference type, may be able to reconcile the empirical findings. In this paper, we systematically investigate, under different market structures, whether selection based on multidimensional private information can result in negative association between insurance coverage and ex post realization of risk in equilibrium. We show that if the insurance market is perfectly competitive, selection based on multidimensional private information does not generate negative association property in equilibrium, unless there is a sufficiently high loading factor. If the insurance market is monopolistic, however, we show that it is possible to generate negative association property in equilibrium when risk type and risk preference type are sufficiently negative dependent, a notion we formalize using the concept of copula. We further show that this result generalizes to imperfectly competitive market structure. We also clarify the confusions in this growing literature about the connections between some of the important concepts such as adverse/advantageous selection and positive/negative association property.
About the Speaker
Hanming Fang is Class of 1965 Term Professor of Economics at the University of Pennsylvania and a Research Associate at the National Bureau of Economic Research (NBER) where he is currently also the Acting Director of its Chinese Economy Working Group.