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Wataru Nozawa
''Failure of the first-order approach in an insurance problem with no commitment and hidden savings''
( 2016, Vol. 36 No.4 )
Efficient insurance contracts in environments with various frictions have been characterized in the literature (see, for example, Thomas and Worrall (1988)). In some environments, the first-order approach suggested by Rogerson (1985) is useful in their characterization. This paper shows that the first-order approach is not valid in an environment with one-sided no commitment and hidden savings under the assumption that the utility function is CRRA or CARA and the return on savings is equal to the inverse of the agent's discount factor. The result complements the numerical result by Ábrahám and Laczó (2014), which suggests that the first-order approach is valid when the return on savings is low.
Keywords: dynamic contract; risk sharing; default; first-order approach
E2 - Macroeconomics: Consumption, Saving, Production, Employment, and Investment: General (includes Measurement and Data)
Description of Appendix:

The appendix for proof of propositions is contained.
Manuscript Received : Mar 22 2016 Manuscript Accepted : Dec 10 2016

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