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Efficient Competitive Equilibria with Adverse Selection

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  • Alberto Bisin
  • Piero Gottardi

Abstract

Do Walrasian markets function orderly in the presence of adverse selection? In particular, is their outcome efficient? This paper addresses these questions in the context of a Rothschild and Stiglitz insurance economy. We identify an externality associated with the presence of adverse selection as a special form of consumption externality. Consequently, we show that while competitive equilibria always exist, they are not typically incentive efficient. However, as markets for pollution rights can internalize environmental externalities, markets for consumption rights can be designed so as to internalize the consumption externality due to adverse selection. With such markets competitive equilibria exist and are always incentive efficient. Moreover, any incentive efficient allocation can be decentralized as a competitive equilibrium.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1504.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1504

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  1. Bennardo, Alberto & Chiappori, Pierre-André, 2002. "Bertrand and Walras Equilibria Under Moral Hazard," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3650, C.E.P.R. Discussion Papers.
  2. Gale, Douglas, 1996. "Equilibria and Pareto Optima of Markets with Adverse Selection," Economic Theory, Springer, Springer, vol. 7(2), pages 207-35, February.
  3. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, Elsevier, vol. 31(1-2), pages 319-325.
  4. John H. Boyd & Edward C. Prescott & Bruce D. Smith, 1988. "Organizations in economic analysis," Working Papers, Federal Reserve Bank of Minneapolis 385, Federal Reserve Bank of Minneapolis.
  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. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, Econometric Society, vol. 60(1), pages 1-42, January.
  7. Bisin, Alberto & Gottardi, Piero, 1999. "Competitive Equilibria with Asymmetric Information," Journal of Economic Theory, Elsevier, Elsevier, vol. 87(1), pages 1-48, July.
  8. Crocker, Keith J. & Snow, Arthur, 1985. "The efficiency of competitive equilibria in insurance markets with asymmetric information," Journal of Public Economics, Elsevier, Elsevier, vol. 26(2), pages 207-219, March.
  9. V.V. Chari & Larry E. Jones, 2000. "A reconsideration of the problem of social cost: Free riders and monopolists," Economic Theory, Springer, Springer, vol. 16(1), pages 1-22.
  10. Alberto Bisin & Piero Gottardi, 2006. "Efficient Competitive Equilibria with Adverse Selection," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 114(3), pages 485-516, June.
  11. 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.
  12. 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.
  13. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, Econometric Society, vol. 47(2), pages 331-59, March.
  14. Bel? Jerez, 2000. "General Equilibrium with Asymmetric Information: a Dual Approach," UFAE and IAE Working Papers, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) 510.02, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  15. Ledyard, John O. & Szakaly-Moore, Kristin, 1994. "Designing organizations for trading pollution rights," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 25(2), pages 167-196, October.
  16. Cole, Harold Linh, 1989. "General Competitive Analysis in an Economy with Private Information: Comment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(1), pages 249-52, February.
  17. Gale, Douglas, 1992. "A Walrasian Theory of Markets with Adverse Selection," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 59(2), pages 229-55, April.
  18. Timothy J. Kehoe & David K. Levine & Edward Prescott, 2000. "Lotteries, Sunspots and Incentive Constraints," Levine's Working Paper Archive 1974, David K. Levine.
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