Unemployed But Optimistic: Optimal Insurance Design with Biased Beliefs
54 Pages Posted: 2 Nov 2008 Last revised: 17 Nov 2008
Date Written: October 29, 2008
Abstract
Biased perceptions of risks change the perceived value of insurance and the perceived returns to avoiding these risks. I show empirically that unemployed workers overestimate how quickly they will find work, but underestimate the return to their search efforts. I analyze the consequences for the optimal design of unemployment insurance. With biased beliefs, contracts equalizing the marginal smoothing benefit and the moral hazard cost of insurance are suboptimal. Social and private insurance diverge; a paternalistic social planner corrects the moral hazard cost for the distortion in the insured's effort choice, while private insurers focus on the perceived rather than the true smoothing benefits. When unemployed workers are optimistic, privatizing unemployment insurance may result in inefficiently low or rapidly decreasing unemployment benefits.
Keywords: Moral Hazard, Biased Beliefs, Unemployment, Optimal Insurance
JEL Classification: D81, D84, D60, G22
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Labor Supply Effects of Social Insurance
By Alan B. Krueger and Bruce D. Meyer
-
Cash-on-Hand and Competing Models of Intertemporal Behavior: New Evidence from the Labor Market
By David Card, Raj Chetty, ...
-
Moral Hazard vs. Liquidity and Optimal Unemployment Insurance
By Raj Chetty
-
Liquidity and Insurance for the Unemployed
By Robert Shimer and Iván Werning
-
Liquidity and Insurance for the Unemployed
By Iván Werning and Robert Shimer
-
A General Formula for the Optimal Level of Social Insurance
By Raj Chetty
-
Unemployment Insurance Savings Accounts
By Martin S. Feldstein and Daniel Altman
-
Reservation Wages and Unemployment Insurance
By Robert Shimer and Iván Werning
-
Reservation Wages and Unemployment Insurance
By Robert Shimer and Iván Werning