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Information and risk in contracts

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Question 1

Why does the assumption of independence of risks matter in the example of insurance? What would happen to premiums if the probabilities of houses burning were positively correlated? Can you think of a situation where they might be negatively correlated?

Question 2

Small firms can discover the abilities of their workers more quickly than large ones because they can observe the workers more closely at a variety of tasks. Does it then make sense for people with high abilities to go to small firms? Give some reasons why and some reasons why not.

Reference no: EM13159804

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