Working Paper 574

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Repeated Insurance Relationships in a Costly State Verification Model: With an Application to Deposit Insurance

Bruce D. Smith
Cheng Wang

Revised September 1, 1997

Abstract
We consider the problem of an insurer who enters into a repeated relationship with a set of risk averse agents in the presence of ex post verification costs. The insurer wishes to minimize the expected cost of providing these agents a certain expected utility level. We characterize the optimal contract between the insurer and the insured agents. We then apply the analysis to the provision of deposit insurance. Our results suggest—in a deposit insurance context—that it may be optimal to utilize the discount window early on, and to make deposit insurance payments only later, or not at all.


Published In: Journal of Monetary Economics (Vol. 42, No. 2, July 1998, pp. 207-240)

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