A:

Moral hazard refers to the way a party acts in a particular situation if protected against risk. It describes the behavioral change of a party when insured against a loss. There are two types of moral hazard, ex-ante and ex-post, and both are different. Ex-ante moral hazard is the change in behavior of a party prior to the outcome of an event, while ex-post moral hazard describes the behavior of a party after the outcome of an event.

Ex-ante moral hazard describes behavior prior to an event occurring. For example, suppose a person, who has no health or life insurance, proceeds with her daily activities in a cautious manner because she knows she has to pay for hospital bills if she gets hurt. She decides to get health and life insurance a few months later. Once her insurance policies go into effect, she begins to engage in hazardous activities, such as skydiving and bungee jumping. Since she is insured, she begins to take more risk than before she had any insurance. This is an example of ex-ante moral hazard.

Ex-post moral hazard refers to the behavior of a party after an event occurs. For example, suppose a person takes out a loan from a bank to start a business. The person changing his behavior to become overly risky with the money is exhibiting ex-ante moral hazard. On the other hand, he may say his business failed, although it was actually profitable, to get a bailout or tax write-off. This is known as ex-post moral hazard.

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