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Incentive Compatibility and Pricing under Moral Hazard

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  • Belen Jerez

    (Universidad Carlos III)

Abstract

We show how to recover equilibrium prices supporting incentive efficient allocations in a classic insurance economy with moral hazard. Our key modeling choice is to impose the incentive compatibility constraints on insurance firms, and not on consumers as in Prescott and Townsend (1984). We show that equilibrium prices of insurance contracts are equal to the sum of the shadow costs arising from the resource and incentive compatibility constraints in the planner's problem. The equilibrium allocations are the same as when the incentive compatibility constraints are imposed on consumers. As in Prescott and Townsend, the two welfare theorems hold. (Copyright: Elsevier)

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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 8 (2005)
Issue (Month): 1 (January)
Pages: 28-47

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Handle: RePEc:red:issued:v:8:y:2005:i:1:p:28-47

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  1. Jerez, Belen, 2003. "A dual characterization of incentive efficiency," Journal of Economic Theory, Elsevier, Elsevier, vol. 112(1), pages 1-34, September.
  2. Timothy J. Kehoe & David K. Levine & Edward Prescott, 2000. "Lotteries, Sunspots and Incentive Constraints," Levine's Working Paper Archive 1974, David K. Levine.
  3. Alberto Bennardo & Pierre-Andre Chiappori, 2003. "Bertrand and Walras Equilibria under Moral Hazard," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 111(4), pages 785-817, August.
  4. Mas-Colell, Andreu & Zame, William R., 1991. "Equilibrium theory in infinite dimensional spaces," Handbook of Mathematical Economics, Elsevier, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 34, pages 1835-1898 Elsevier.
  5. Edward C Prescott & Robert M Townsend, 1997. "General Competitive Analysis in an Economy with Private Information," Levine's Working Paper Archive 1578, David K. Levine.
  6. Feldman, Mark & Gilles, Christian, 1985. "An expository note on individual risk without aggregate uncertainty," Journal of Economic Theory, Elsevier, Elsevier, vol. 35(1), pages 26-32, February.
  7. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 90(4), pages 630-49, November.
  8. Bisin, Alberto & Gottardi, Piero, 1999. "Competitive Equilibria with Asymmetric Information," Journal of Economic Theory, Elsevier, Elsevier, vol. 87(1), pages 1-48, July.
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  10. Sun, Yeneng, 1998. "A theory of hyperfinite processes: the complete removal of individual uncertainty via exact LLN1," Journal of Mathematical Economics, Elsevier, vol. 29(4), pages 419-503, May.
  11. Belen Jerez, 2000. "General Equilibrium with Asymmetric Information: A Dual Approach," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1497, Econometric Society.
  12. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, Elsevier, vol. 16(2), pages 167-207, December.
  13. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, Econometric Society, vol. 52(1), pages 21-45, January.
  14. Pradeep Dubey & John Geanakoplos & Martin Shubik, 1988. "Default and Efficiency in a General Equilibrium Model with Incomplete Markets," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 879R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1989.
  15. Alberto Bisin & Piero Gottardi, 2000. "Decentralizing Incentive Efficient Allocations of Economies with Adverse Selection," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 0855, Econometric Society.
  16. Arnott, Richard & Greenwald, Bruce & Stiglitz, Joseph E., 1994. "Information and economic efficiency," Information Economics and Policy, Elsevier, Elsevier, vol. 6(1), pages 77-82, March.
  17. Gretsky, Neil E. & Ostroy, Joseph M. & Zame, William R., 1999. "Perfect Competition in the Continuous Assignment Model," Journal of Economic Theory, Elsevier, Elsevier, vol. 88(1), pages 60-118, September.
  18. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, Econometric Society, vol. 53(1), pages 69-76, January.
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Citations

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Cited by:
  1. João Correia da Silva & Carlos Hervés-Beloso, 2012. "Existence and generic efficiency of equilibrium in two-period economies with private state-verification," FEP Working Papers, Universidade do Porto, Faculdade de Economia do Porto 443, Universidade do Porto, Faculdade de Economia do Porto.
  2. Piero Gottardi & Belén Jerez, 2006. "A Note on Walrasian Equilibria with Moral Hazard and Aggregate Uncertainty," Working Papers 2006_43, Department of Economics, University of Venice "Ca' Foscari".
  3. Bisin, Alberto; & Gottardi, Piero; & Ruta, Guido, 2014. "Equilibrium corporate finance and intermediation," Economics Working Papers, European University Institute ECO2014/09, European University Institute.
  4. Joon Song, 2007. "Futures Market: Contractual Arrangement to Restrain Moral Hazard in Teams," Economics Discussion Papers, University of Essex, Department of Economics 633, University of Essex, Department of Economics.
  5. Joao Correia-da-Silva & Carlos Herves-Beloso, 2008. "General equilibrium with private state verification," Levine's Working Paper Archive 814577000000000024, David K. Levine.
  6. João Correia-da-Silva & Carlos Hervés-Beloso, 2014. "Irrelevance of private information in two-period economies with more goods than states of nature," Economic Theory, Springer, Springer, vol. 55(2), pages 439-455, February.
  7. Joao Correia-da-Silva & Carlos Herves-Beloso, 2010. "Two-period economies with private state verification," FEP Working Papers, Universidade do Porto, Faculdade de Economia do Porto 374, Universidade do Porto, Faculdade de Economia do Porto.
  8. João Correia da Silva, 2014. "Two-period economies with price-contingent deliveries," FEP Working Papers, Universidade do Porto, Faculdade de Economia do Porto 529, Universidade do Porto, Faculdade de Economia do Porto.
  9. Paolo Siconolfi & Aldo Rustichini, 2012. "Economies with Observable Types," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(1), pages 57-71, January.
  10. Aldo Rustichini & Paolo Siconolfi, 2008. "General equilibrium in economies with adverse selection," Economic Theory, Springer, Springer, vol. 37(1), pages 1-29, October.

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