Conferences at Department of Economics, University of Toronto, Canadian Economic Theory Conference 2022

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Insurance and Inequality with Persistent Private Information

Alex Bloedel*, R. Vijay Krishna, Oksana Leukhina

Last modified: 2022-04-17


This paper studies the implications of optimal insurance provision for long-run welfare and inequality in economies with persistent private information. We consider a model in which a principal insures an agent whose privately observed endowment follows an ergodic, finite Markov chain. The optimal contract always induces immiseration: the agent’s consumption and utility decrease without bound. Under positive serial correlation, the optimal contract also features backloaded high-powered incentives: the sensitivity of the agent’s utility with respect to his report increases without bound. These results significantly extend — and elucidate the limits of — the hallmark immiseration results for economies with iid private information. Our analysis utilizes recursive techniques for contracting with persistent states, accounts for the possibility of binding global incentive constraints, extends to other canonical insurance settings (e.g., Mirrleesian economies), and has additional implications for the short-run dynamics of optimal contracts.

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