A Continuous-Time Optimal Insurance Design with Costly Monitoring |
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Authors: | Hisashi Nakamura Koichiro Takaoka |
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Institution: | 1. Graduate School of Commerce and Management, Hitotsubashi University, 2-1 Naka, Kunitachi, Tokyo, 186-8601, Japan
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Abstract: | We provide a theoretical and numerical framework to study optimal insurance design under asymmetric information. We consider a continuous-time model where neither the efforts nor the outcome of an insured firm are observable to an insurer. The insured may then cause two interconnected information problems: moral hazard and fraudulent claims. We show that, when costly monitoring is available, an optimal insurance contract distinguishes the one problem from the other. Furthermore, if the insured’s downward-risk aversion is weak and if the participation constraint is not too tight, then a higher level of the monitoring technology can mitigate both problems. |
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