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Dynamic optimal insurance and lack of commitment

Alexander Karaivanov and Fernando Martin

No 2011-029, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper analyzes dynamic risk-sharing contracts between profit-maximizing insurers and risk-averse agents who face idiosyncratic income uncertainty and may self-insure through savings. We study Markov-perfect insurance contracts in which neither party can commit beyond the current period. We show that the limited commitment assumption on the insurer's side is only restrictive when he is endowed with a rate of return advantage and the agent has sufficiently large initial assets. In such a case, the consumption profile is distorted relative to the first-best. In a Markov-perfect equilibrium, the agent's asset holdings determine his period outside option and are thus, an integral part of insurance contracts, unlike the case when the insurer can commit. Whether the parties can contract on the agent's savings decisions or not affects the agreement as long as the insurer makes positive profits.

Keywords: Contracts; Risk (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-dge, nep-ias and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Dynamic Optimal Insurance and Lack of Commitment (2015) Downloads
Working Paper: Dynamic Optimal Insurance and Lack of Commitment (2007) Downloads
Working Paper: Dynamic Optimal Insurance and Lack of Commitment (2007) Downloads
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