Question

1. Describe the insurance contract offered to the robust in the asymmetric information separating equilibrium with the one offered in a symmetric information setup. Do you see differences in what is offered? Why? Only text, no graphs.

Answer 1

Asymmetric Information separating equilibrium

In simple words we can say that asymmetric information is the one in which there is 'imperfect knowledge'. Which means that, among two parties, the first party has more material knowledge than the other or vice versa (in any transaction). This can also be called information asymmetries. Separating equilibrium is when two parties tend to choose different strategies i.e., rather than choosing the same strategy which the first party has chosen, the second party will choose a different strategy which the first party has not chosen.

Symmetric Information

Here, perfect knowledge can exist, i.e., both the parties have some material knowledge (sometimes not same) but both the parties tend to have some information which they can use while doing a transaction with each other.

Insurance Contract in Asymmetric information

If we take in terms of an insurance contract there are two types of customers; Risk takers and Risk averse.

Risk takers are the one who are ready to make a claim (if there is any).

Risk averse are the ones who avoid in taking risk i.e., they are the ones who are not ready to make a claim (if there is any).

In this case we have to describe the insurance contract offered to Robust in Asymmetric information. Let's begin.

Assume that there are three parties A, B and C.

A is the insurer and B and C are the consumers who will be taking insurance. There is Asymmetric information i.e Let's assume A has more knowledge about the contract as he is an insurer, than B and C but does not know who is a risk taker and who is a risk averse, but B and C knows themselves whether they are risk taker or risk averse.

A is offering Separating contracts to B and C which means that B and C has to decide what contract they will take. As there is separating equilibrium they will tend to choose different strategies. If B is a risk taker and C is a risk averse then, the insurance company would not offer a contract to a risky customer who doesn't make effort to make a claim (Here B). On the other hand the insurance company would offer a contract to a person who is a risk averse, to C (here).

Now if C is a robust and who is also an risk averse, he would analyse all the offers which are given to him by insurance company but he is unknown about the hidden parts of the contract. Plus he will be also independent of the choices of A. (Separate equilibrium).

The risk taker will also buy insurance at the cheap rate as compared to the risk averse. (He fully knows about the insurance facts). So this can also lead to losses for the insurance company.

There is a Asymmetric information arising between the parties. As some of the information is private for each of them.

Insurance contract in Symmetric information

Now here, A knows that which party is a risk taker and who is a risk averse. In this the insurance company will offer the contract depending upon this fact that who is a risk taker and who is a risk averse. A will not offer such contract to risk taker which would push him in a risky condition as it would be probable for him to make a loss.

On the other hand A will offer such a contract to C that would suit him/her. (According to the type of risk) (here, risk averse).

And if both the parties (B and C), are known fully about the facts of the contract, then it will be also helpful for them to analyse the contract information. We can also discuss about the full insurance and the partial insurance offered by insurance company.

In the terms of insurance, risk takers will take more insurance than risk averse.

This is Symmetric information arising between the parties. As none of the facts are hidden.

•There is a huge difference in what is offered in Asymmetric information than what is offered in symmetric information. Because in Asymmetric setup there is lack of information between the parties and on the other hand in Symmetric setup we can say that there is 'perfect knowledge' between parties, Hence more is offered in symmetric than Asymmetric.