Advantageous Selection in a Dynamic Framework

This paper investigates how advantageous selection can occur in a dynamic framework. In a framework that allows for investing in health, there is not only a direct, but also an indirect effect of preferences and risk aversion on the choices an individual makes. The indirect effect arises as current choices also affect future health, which in turn will influence future choices. I show that due to this kind of dynamic effects, the correlation between health and preferences (or risk aversion) arises naturally. This is in contrast with the static model that needed to assume this correlation to generate advantageous selection. It is also not necessary to assume that individuals in good health have a smaller probability of being hit by a health shock than individuals in bad health. Even if the probability of a health shock is the same for all individuals, irrespective of their health, the correlation between health and preferences (or risk aversion) arises naturally. And with this correlation also advantageous selection.