An Adverse Selection Model of Optimal Unemployment

Abstract

We ask whether offering a menu of unemployment insurance contracts is welfare improving in a heterogeneous population. We adopt a repeated moral-hazard framework as in Shavell/Weiss (1979) supplemented by unobservednheterogeneity about agents’ job opportunities. Our main theoretical contribution is an analytical characterizationnof the sets of jointly feasible entitlements that renders annefficient computation of these sets feasible. Our main economicnresult is that optimal contracts for ”bad” searchers tend to be upward-sloping due to an adverse-selection effect.nThis is in contrast to the well-known optimal decreasingntime-profile of benefits in pure moral hazard environmentsnthat continue to be optimal for ”good” searchers in our model.