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In this paper, we address the identification and estimation of insurance models where insurees have private information about their risk and risk aversion. The model includes random damages and allows for several claims, while insurees choose from a finite number of coverages. We show that the joint distribution of risk and risk aversion is nonparametrically identified despite bunching due to multidimensional types and a finite number of coverages. Our identification strategy exploits the observed number of claims as well as an exclusion restriction, and a full support assumption. Furthermore, our results apply to any form of competition. We propose a novel estimation procedure combining nonparametric estimators and GMM estimation that we illustrate in a Monte Carlo study.

In the producer–seller relationship, the seller, besides his role of selling, is often in an ideal position to gather useful market information for the producer’s operations planning. Incentive alignment is critical to motivate both information-acquisition and sales efforts. Two popular contract forms are investigated. One is the forecast-based contract (FC) that requires the seller to submit a demand forecast: the seller obtains commissions from the realized sales but is also obliged to pay a penalty for any deviation of the sales from the forecast. The other is the classical menu of linear contracts (MLC), from which the seller can choose a contract that specifies a unique commission rate and a fixed payment. The conventional understanding suggests that the MLC is superior, but it is often assumed that information is exogenously endowed. In contrast, we find that, with an endogenous information-acquisition effort, the MLC may suffer from a conflicted moral hazard effect that creates friction between motivations for the two efforts. The FC can, however, decouple these two tasks and thus dominate the MLC. We further find that when ensuring interim participation is necessary (e.g., renegotiation cannot be prevented after information acquisition), the performance of the FC might be affected by the adverse selection effect because it is unable to effectively separate different types, at which the MLC excels. We show that when the demand and supply mismatch cost is substantial, the conflicted moral hazard effect dominates the adverse selection effect, and the FC is more efficient, and it is the converse otherwise. These findings can enrich the understanding of these two contract forms and are useful for sales and operations planning. This paper was accepted by Yossi Aviv, operations management .

Commerce depends on buyers and sellers fulfilling their contractual obligations; mechanisms inducing such performance are essential to well-functioning markets. Internet-enabled reputation mechanisms that collect and disseminate consumer feedback have emerged as prominent means for inducing seller performance in online and offline markets. This paper compares the ability of reputation and more traditional litigation-like mechanisms for dispute resolution to induce efficient economic outcomes. We use a game-theoretic formulation and derive results for their relative efficiency and effectiveness individually or as complements. We find that the popular view of reputation as an efficient and relatively costless way to induce seller effort under all circumstances is incorrect; reputation is less efficient than litigation in inducing any given level of effort. Thus, reputation improves efficiency only in settings where the high cost of litigation, insufficient damage levels, or low court accuracy induce suboptimal effort or cause market failure. When adverse selection is important, reputation helps reveal the true types of market participants, which may offset its higher cost of inducing effort. Finally, adding reputation to existing litigation mechanisms increases seller effort and may require adjusting damage awards to avoid inducing excessive effort that reduces economic efficiency. This paper was accepted by Lorin Hitt, information systems.

The objective of this paper is to pursue an intuitive idea: for a consumer who represents an “unfavorable” health risk but an “excellent risk” as a driver, a multi-peril policy could be associated with a reduced selection effort on the part of the insurer. If this intuition should be confirmed, it will serve to address the decade-long concern with risk selection both in the economic literature and on the part of policy makers. As an illustrative example, a two-peril model is developed in which consumers deploy effort in search of a policy offering them maximum coverage at the current market price while insurers deploy effort designed to stave off unfavorable risks. Two types of Nash equilibria are compared: one in which the insurer is confronted with high-risk and low-risk types, and another one where both types are a “better risk” with regard to a second peril. The difference in the insurer’s selection effort directed at high-risk and low-risk types is indeed shown to be lower in the latter case, resulting in a mitigation of adverse selection.

We develop a model of financial maintenance covenants under moral hazard, adverse selection, and informative signals of varying quality. We explain how public signals can improve the outcome for lenders and borrowers by reducing inefficient risk-taking (in both the pooling and separating equilibrium), and by shielding good firms from the actions of bad (separating) ones. We find that a reduction in signal quality moves the equilibrium from pooling to separating, to no covenants at all. We also demonstrate that signal quality has a non-monotone effect on covenant strictness. In an extension, we model manipulation of the accounting signal and show that it is isomorphic to a particular kind of noise.

We document a basic characteristic of adverse selection in secondhand markets for durable goods: goods with higher observed quality may have more adverse selection and hence lower unobserved quality. We provide a simple theoretical model to demonstrate this result, which is a consequence of the interaction of sorting between drivers over observed quality and adverse selection over unobserved quality. We then offer empirical support using data on secondhand prices and repair rates of used cars from the Consumer Expenditure Survey, and discuss a number of implications for everyday advertising and consumer questions. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2016.2495 . This paper was accepted by J. Miguel Villas-Boas, marketing .

This paper studies a manufacturer that sells to a newsvendor retailer who can improve the quality of her demand information by exerting costly forecasting effort. In such a setting, contracts play two roles: providing incentives to influence the retailer's forecasting decision and eliciting information obtained by forecasting to inform production decisions. We focus on two forms of contracts that are widely used in such settings and are mirror images of one another: a rebates contract, which compensates the retailer for the units she sells to end consumers, and a returns contract, which compensates the retailer for the units that are unsold. We characterize the optimal rebates contracts and returns contracts. Under rebates, the retailer, manufacturer, and total system may benefit from the retailer having inferior forecasting technology; this never occurs under returns. Although one might conjecture that returns would be inferior because its provision of \"insurance\" would discourage the retailer from forecasting, we show that returns are superior.

Even 30 years after Rothschild and Stiglitz's (1976) seminal work on competitive insurance markets with adverse selection, existence and characterization of the equilibrium outcome are still an open issue. We model a basic extension to the Rothschild and Stiglitz model: we endogenize up-front capital of insurers. Under limited liability, low up-front capital gives rise to an aggregate endogenous insolvency risk, which introduces an externality among customers of an insurer (Faynzilberg, 2006). It is shown that an equilibrium with the second-best efficient Miyazaki-Wilson-Spence allocation always exists.

We study how innovators can optimally design licensing contracts when there is incomplete information on the licensee's valuation of the innovation, and limited control over the licensee's development efforts. A licensing contract typically contains an up-front payment, milestone payments at successful completion of a project phase, and royalties on sales. We use principal-agent models to formulate the licensor's contracting problem, and we find that under adverse selection, the optimal contract structure changes with the licensee's valuation of the innovation. As the licensee's valuation increases, the licensor's optimal level of involvement in the development-directly or through royalties-should decrease. Only a risk-averse licensor should include both up-front and milestone payments. Moral hazard alone is not detrimental to the licensor's value, but may create an additional value loss when combined with adverse selection. Our results inform managerial practice about the advantages and disadvantages of the different terms included in licensing contracts and recommend the optimal composition of the contract.

We develop an equilibrium concept in the Debreu (Proc Natl Acad Sci USA 40(7):588–592, 1954) theory of value tradition for a class of adverse selection economies which includes the Spence (Q J Econ 87(3):355–374, 1973) signaling and Rothschild-Stiglitz (Q J Econ 90(4):629–649, 1976) insurance environments. The equilibrium exists and is optimal. Further, all equilibria have the same individual type utility vector. The economies are large with a finite number of types that maximize expected utility on an underlying commodity space. An implication of the analysis is that the invisible hand works for this class of adverse selection economies.