Lec_16_financial_crisis

Lec_16_financial_crisis - Chapter 12 Economics of...

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1 Second exam will cover only Chapters 10- 12 Final exam will be cumulative for entire course Answers to practice second exam will be reviewed in discussion sections week of Wed Feb 18 to Mon Feb 23 No class or discussion sections on Mon Feb 16 Chapter 12: Economics of Information F. Resolving asymmetric information with costly signaling G. Insurance markets Potential problems with insurance markets: (1) adverse selection Suppose drivers risk averse and willing to pay $2 premium for $1 expected payoff Expected payout for safe drivers: (1/200) x ($20,000) = $100 per year Expected payout for risky drivers: (1/20) x ($20,000) = $1,000 per year Safe drivers are willing to pay $200/year premium Risky drivers are willing to pay $2,000/year premium Conclusion: if insurance policy costs $550, only the risky drivers would buy it If only risky drivers buy it, insurance company’s expected payout is $2,000 Insurance will cost $2,000 in equilibrium Definition: adverse selection refers to the phenomenon where high-risk individuals are more likely to buy insurance than low- risk individuals, thereby raising insurance payouts and equilibrium premia One way insurance companies cope with adverse selection: statistical discrimination Insurance company uses some aspect of driver that they can identify that correlates with payout rates driving record age zip code
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2 Potential problems with insurance markets: (1) Adverse selection (2) Moral hazard Once I have insurance, I no longer personally pay the cost for my risky behavior If I engage in more risky behavior precisely
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