Optimal insurance under costly falsification and costly, inexact verification
Journal of Economic Dynamics and Control
Claim falsification, Inexact verification, Optimal indemnity schedule, Optimal insurance contract, Revelation principle
This paper integrates the often dichotomized models of costly state verification and costly claim falsification. It is found that when verification is inexact, it is possible for an optimal insurance contract to consist of both positive claim falsification and positive insurer verification, provided that falsification cost and verification cost are sufficiently low, and the insured is risk-averse satisfying constant absolute risk aversion. This result certainly contrasts with the common belief that falsification and verification are mutually exclusive in an optimal insurance contract. Some characteristics of the optimal falsification, verification, and indemnification profiles, including implementability, are analyzed.
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Hau, A. (2008). Optimal insurance under costly falsification and costly, inexact verification. Journal of Economic Dynamics and Control, 32(5), 1680-1700. doi: 10.1016/j.jedc.2007.06.014