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 •a g e
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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 because I am insured it is called moral hazard Chapter 12: Economics of
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This note was uploaded on 09/17/2009 for the course ECON ECON 2 taught by Professor Hamilton during the Spring '09 term at UCSD.

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Lec_16_financial_crisis - Chapter 12: Economics of...

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