Testing Adverse Selection with Two-Dimensional Information: Evidence from Singapore Auto Insurance Market

36 Pages Posted: 21 Feb 2011 Last revised: 27 Sep 2011

See all articles by Peng Shi

Peng Shi

University of Wisconsin - Madison

Wei Zhang

Northern Illinois University

Emiliano A. Valdez

University of Connecticut - Department of Mathematics

Date Written: September 1, 2011

Abstract

This article examines adverse selection in insurance markets within a two-dimensional information framework, where policyholders differ in both their riskiness and degree of risk aversion. Using this setup, we first build a theoretical model to make equilibrium predictions on competitive insurance screening. We study several variations on the pattern of information asymmetry. The outcomes range from full risk separation, to partial separation, to complete pooling of different risk types. Next, we examine results of this construction with an empirical investigation using a cross sectional observation from a major automobile insurer in Singapore. To test for evidence of adverse selection, we propose a copula regression model to jointly examine the relationship between policyholders' coverage choice and accident occurrence. The association parameter in copula provides evidence of asymmetric information. Furthermore, we invoke the theory to identify subgroups of policyholders for whom one may expect the risk-coverage correlation and adverse selection to arise. The empirical findings are largely consistent with theoretical predictions.

Keywords: Adverse selection, Two-dimensional information, Risk aversion, Insurance screening, Copula models

JEL Classification: B41, C19, D82, G22

Suggested Citation

Shi, Peng and Zhang, Wei and Valdez, Emiliano A., Testing Adverse Selection with Two-Dimensional Information: Evidence from Singapore Auto Insurance Market (September 1, 2011). Available at SSRN: https://ssrn.com/abstract=1765365 or http://dx.doi.org/10.2139/ssrn.1765365

Peng Shi

University of Wisconsin - Madison ( email )

School of Business
975 University Ave
Madison, WI 53706-1481
United States

Wei Zhang

Northern Illinois University ( email )

Department of Economics
Zulauf Hall 515
DeKalb, IL 60115
United States

Emiliano A. Valdez (Contact Author)

University of Connecticut - Department of Mathematics ( email )

341 Mansfield Road U-1009
Storrs, CT 06269-1009
United States

HOME PAGE: http://www.math.uconn.edu/~valdez

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