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We examine the demand for underwriting and its effect on equilibrium in an insurance market in which insureds know their risk type, but insurers do not. Our analysis indicates that a set of policies including one that requires buyers to take an underwriting test can constitute a full coverage Nash equilibrium when perfect classification is possible. We also find that underwriting equilibria, in which low risks obtain greater coverage than they would without underwriting, widely exist in a Wilsonian market with nonmyopic insurers. Our findings provide a potential explanation for why empirical evidence on adverse selection is mixed.
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Browne et al. (2011) studied this question.
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