Failure of the first-order approach in an insurance problem with no commitment and hidden savings

Wataru Nozawa

Economics Bulletin, 2016, vol. 36, issue 4, 2422-2429

Abstract: Efficient insurance contracts in environments with various frictions have been characterized in the literature (see, for example, Thomas and Worrall (1988)). In some environments, the first-order approach suggested by Rogerson (1985) is useful in their characterization. This paper shows that the first-order approach is not valid in an environment with one-sided no commitment and hidden savings under the assumption that the utility function is CRRA or CARA and the return on savings is equal to the inverse of the agent's discount factor. The result complements the numerical result by à brahám and Laczó (2014), which suggests that the first-order approach is valid when the return on savings is low.

Keywords: dynamic contract; risk sharing; default; first-order approach (search for similar items in EconPapers)
JEL-codes: E2 G0 (search for similar items in EconPapers)
Date: 2016-12-10
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Citations: View citations in EconPapers (1)

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