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Competitive Insurance Markets and Adverse Selection in the Lab

Dorra Riahi Berraies (), Louis Lévy-Garboua () and Claude Montmarquette ()

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Abstract: We provide an experimental analysis of competitive insurance markets with adverse selection. Our parameterized version of the lemons' model (Akerlof 1970) in the insurance context predicts total crowding out of low-risks when insurers offer a single full insurance contract .The therapy proposed by Rothschild and Stiglitz (1976) consists of adding a partial insurance contract so as to obtain selfselection of risks. We test the theoretical predictions of these two models in two experiments. A clean test is obtained by matching the parameters of these experiments and by controlling for the risk neutrality of insurers and the common risk aversion of their clients by means of the binary lottery procedure. The results reveal a partial crowding out of low risks in the first experiment. Crowding out is not eliminated in the second experiment and it is not even significantly reduced. Finally, instead of the predicted separating equilibrium, we find pooling equilibria. The latter can be sustained because insureds who objectively differ in their risk level do not perceive themselves as being so much different.

Keywords: experimental economics; insurance markets; adverse selection; binary lottery procedure; expected utility (search for similar items in EconPapers)
Date: 2013-03
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Published in Geneva Risk and Insurance Review, Palgrave Macmillan, 2013, 38, pp.87-113. ⟨10.1057/grir.2012.5⟩

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