With asymmetric information, full commitment to long-term contracts may permit markets to approach first-best allocations. However, commitment can be undermined by opportunistic behavior, notably renegotiation. We reexamine commitment in insurance markets. We present an alternative model (which extends Laffont and Tirole's procurement model to address uncertainty and competition), which involves semipooling in the first period followed by separation. This and competing models (e.g., single-period models and no-commitment models) have different predictions concerning temporal patterns of insurer profitability. A test using California data suggests that some automobile insurers use commitment to attract selective portfolios comprising disproportionate numbers of low risks.

Insurance fraud is now recognized as a significant resource-allocation problem in many markets. The object of this study is to verify how straight deductible contracts may affect the equilibrium level of falsification in automobile insurance. This type of contract is observed in many markets, even if it is not optimal under costly state falsification. A higher deductible may create incentives to fraud or cheat, particularly when the insured anticipates that the claim has a small probability of being audited. To verify this proposition, we estimate a loss equation for which one of the determinants is the amount of the deductible, using a data set of claims filed for damages following an automobile accident with twenty insurance companies in Quebec in 1992. Because we have access only to reported losses, a higher deductible also implies a lower probability of reporting small losses. To isolate the fraud effect related to the presence of a deductible in the contract, we jointly estimate a loss equation and a threshold equation. The threshold is the amount over which an insured decides to report a given loss. It can be interpreted as a personal deductible, and it is not observable. Our results indicate, among other things, that with an appropriate correction for selectivity the amount of the deductible is a significant determinant of the reported loss, at least when no other vehicle is involved in the accident; in other words, when the presence of witnesses is less likely.

For many years, economists and actuaries have studied multiperiod insurance contracts independently and differently. The aim of this article is to reduce the gap between empirical studies on the determination of insurance premiums and theoretical studies on moral hazard and experience rating. The first objective is to verify empirically the proposition that past experience is a good predictor of risk by using data from a random sample consisting of 19, 013 car drivers in Quebec. The second objective is to construct a multivariate, multiperiod pricing formula for automobile insurance in order to reduce the ill effects of moral hazard.

According to Basel II criteria, the use of external data is indispensable to the implementation of an advanced method for calculating operational risk capital. This article investigates how the severity and frequencies of external losses are scaled for integration with internal data. We set up an initial model designed to explain the loss severity by taking into account potential selection bias in the external data. Estimation results show that many variables have significant power in explaining the loss amount. We use them to develop a normalization formula. We develop a zero-inflated count-data model to scale the loss frequency. We compute an operational VaR and we conduct out-of-sample backtesting.

Two types of moral hazard have been determined. The first type is related to self-prevention activities affecting probabilities of accidents. The second type relates to the agent's activities whenever the accident occurs. The authors' objective consists of presenting an empirical measure of the significance of this second type of moral hazard in the workers' compensation market. The main challenge in isolating moral hazard consists of dividing into two parts the total variation in recovery time with respect to changes in insurance coverage: (1) the variation of consumption corresponding to a given level of information; and (2) the variation of consumption due to greater asymmetrical information. The methodology used in this study separates these two variations.

The contingent claims analysis of firm financing often presents a debt renegotiation game with a passive bank that does not use its ability to force liquidation strategically, contrary to what is observed in practice. We consider two motives that may lead a bank to refuse to renegotiate: maintaining its reputation to preserve its future lending activity and deterring firms from overstating their debt service abatement when they renegotiate. We show that with public information and private debt only, the optimal probability of debt renegotiation is high when the firm’s anticipated liquidation value is high. Under asymmetric information about liquidation value, the high liquidation value firm may be tempted to mimic the low liquidation value firm to reduce its debt service. To deter such mimicking, banks may sometimes refuse to renegotiate with firms having a low liquidation value.

With asymmetric information, full commitment to long-term contracts may permit markets to approach first-best allocations. However, commitment can be undermined by opportunistic behavior, notably renegotiation. The authors reexamine commitment in insurance markets. They present an alternative model (which extends Jean-Jaques Laffont and Jean Tirole's procurement model to address uncertainty and competition), which involves semipooling in the first period followed by separation. This and competing models (e.g., single-period models and no-commitment models) have different predictions concerning temporal patterns of insurer profitability. A test using California data suggests that some automobile insurers use commitment to attract selective portfolios comprising disproportionate numbers of low risks.

Information asymmetry is a necessary prerequisite for testing adverse selection. This paper applies this sequence of tests to Mauritian slave auctions. The theory of dynamic auctions with private and common values suggests that when an informed participant is known to be active, uninformed bidders will be more aggressive and the selling price will be higher. We conjecture that observable family links between buyer and seller entailed superior information and find a strong price premium when a related buyer purchased a slave, indicative of information asymmetry. We then test for adverse selection using sale motivation. Our results indicate large discounts on voluntary as compared to involuntary sales. Consistent with adverse selection, the market anticipated that predominantly low-productivity slaves would be brought to the market in voluntary sales.

We investigate the dynamics of corporate hedging programs used by US oil producers and examine the effects of hedging maturity choice on firm value. We find evidence of a concave relationship between hedging maturity and the likelihood of financial distress and oil spot prices. We further investigate the motivations of the early termination of outstanding hedging contracts. Using the essential heterogeneity approach, we evaluate the causal effects of hedging maturity on firm value. Marginal firm value increases with short-term hedging maturity. The causal effects vary across oil producers with different hidden attributes.

In this note, we present a strategy which relies on multi-period contracts and on a self-selection mechanism which induces the insured to announce his true risk in the first period, thus eliminating inefficiency due to adverse selection.