Equilibrium in Competitive Insurance Markets Under Adverse Selection and Yaari's Dual Theory of Risk

Virginia R. Young and Mark J. Browne
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Virginia R. Young: School of Business, University of Wisconsin-Madison, Madison, Wisconsin 53706, USA, e-mail: vyoung@bus.wisc.edu
Mark J. Browne: School of Business, University of Wisconsin-Madison, Madison, Wisconsin 53706, USA

The Geneva Risk and Insurance Review, 2000, vol. 25, issue 2, 157 pages

Abstract: Under Yaari's dual theory of risk, we determine the equilibrium separating contracts for high and low risks in a competitive insurance market, in which risks are defined only by their expected losses, that is, a high risk is a risk that has a greater expected loss than a low risk. Also, we determine the pooling equilibrium contract when insurers are assumed non-myopic. Expected utility theory generally predicts that optimal insurance indemnity payments are nonlinear functions of the underlying loss due to the nonlinearity of agents' utility functions. Under Yaari's dual theory, we show that under mild technical conditions the indemnity payment is a piecewise linear function of the loss, a common property of insurance coverages. The Geneva Papers on Risk and Insurance Theory (2000) 25, 141–157. doi:10.1023/A:1008762312418

Date: 2000
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