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I am trying to understand the statmement that 'public information kills insurance opportunity' -- referred to as Hirshleifer effect. Does it (in general) lead to some undesirable outcomes? Could you explain that to me with a simple example? For me it is easy to form examples of trade breaking when there is asymmetric information (adverse selection for example) and that having an undesirable effects. But I am not able to fully grasp the meaning and consequences of Hirshleifer effect.

Thanks

UPDATE: Here is what I thought could be a simple example. Suppose there are two periods ($t_0, t_1$) and two possible states of nature ($s_1,s_2 $) that arise in period $t_1$. Suppose there are two agents. The first agent has an income stream that pays off only in state $s_1$ while, second agent's income stream pays off only in state $s_2$. Consumption happens only in $t_1$ and both agents prefer to consume in both the states than in just one (Inada condition as consuption goes to 0 is not satisfied) and more is always better. If at $t_0$, neither agent knows the state at $t_1$ then they might enter into a trade that ensures them positive consumption across both the states.

On the other hand, if, in $t_0$, state is already revealed publicly (in this example even privately to one agent) an agent who has a positive pay-off in $t_1$ would not be interested in any trade with the unlucky agent.

Is this way of thinking in the example correct?

Thanks for any comment

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  • $\begingroup$ This is exactly right. The only way that insurances can work is if there is uncertainty at the moment of signing the insurance contract. If you learn my genetic test results that say that with very high probability I'll get a chronic disease, you'll not want to provide insurance to me, for example. $\endgroup$ – Regio Apr 26 at 17:34
  • $\begingroup$ Thank you @GabrielMartínez for confirming my intuition. $\endgroup$ – user200947 Apr 27 at 4:34
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Here is what I thought could be a simple example. Suppose there are two periods ($t_0, t_1$) and two possible states of nature ($s_1,s_2 $) that arise in period $t_1$. Suppose there are two agents. The first agent has an income stream that pays off only in state $s_1$ while, second agent's income stream pays off only in state $s_2$. Consumption happens only in $t_1$ and both agents prefer to consume in both the states than in just one (Inada condition as consuption goes to 0 is not satisfied) and more is always better. If at $t_0$, neither agent knows the state at $t_1$ then they might enter into a trade that ensures them positive consumption across both the states.

On the other hand, if, in $t_0$, state is already revealed publicly (in this example even privately to one agent) an agent who has a positive pay-off in $t_1$ would not be interested in any trade with the unlucky agent.

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