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Decentralizing Incentive Efficient Allocations of Economies with Adverse Selection

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  • Alberto Bisin

    (New York University)

  • Piero Gottardi

    (Universita di Venezia)

Abstract

We study competitive economies with adverse selection and fully exclusive contractual relationships. We consider economies where agents are privately informed over the probability distribution of their endowments, and trade to insure against this uncertainty. As in Prescott-Townsend (1984), we model exclusivity by imposing the incentive compatibility constraints directly on the agents' consumption possibility set. In this set-up, we identify the externality associated with the presence of adverse selection as a special form of consumption externality. We consider a structure of markets which allows to internalize such externality, for which we show that competitive equilibria exist and are incentive efficient. On the other hand, when this 'expanded' set of markets required to internalize such externality does not exist, competitive equilibria are shown to be, typically, not incentive efficient, but to satisfy an appropriately defined notion of third best efficiency. Appropriate versions of the second welfare theorem for these two market structures are also established.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 0855.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:0855

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  1. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
  2. Pradeep Dubey & John Geanakoplos & Martin Shubik, 1988. "Default and Efficiency in a General Equilibrium Model with Incomplete Markets," Cowles Foundation Discussion Papers 879R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1989.
  3. 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.
  4. Gale, Douglas, 1992. "A Walrasian Theory of Markets with Adverse Selection," Review of Economic Studies, Wiley Blackwell, vol. 59(2), pages 229-55, April.
  5. E. Kohlberg & J.-F. Mertens, 1998. "On the Strategic Stability of Equilibria," Levine's Working Paper Archive 445, David K. Levine.
  6. 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, vol. 30(1), pages 249-52, February.
  7. Bel? Jerez, 2000. "General Equilibrium with Asymmetric Information: a Dual Approach," UFAE and IAE Working Papers 510.02, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  8. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  9. Dasgupta, Partha & Maskin, Eric, 1986. "The Existence of Equilibrium in Discontinuous Economic Games, I: Theory," Review of Economic Studies, Wiley Blackwell, vol. 53(1), pages 1-26, January.
  10. Alberto Bisin & Piero Gottardi, 1998. "Competitive Equilibria with Asymmetric Information," Levine's Working Paper Archive 2062, David K. Levine.
  11. John G. Riley, 1976. "Informational Equilibrium," UCLA Economics Working Papers 071, UCLA Department of Economics.
  12. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January.
  13. Michael Magill & Martine Quinzii, . "Incentives And Risk Sharing In A Stock Market Equilibrium," Department of Economics 96-12, California Davis - Department of Economics.
  14. 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, vol. 90(4), pages 630-49, November.
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Cited by:
  1. Belén Jerez, 2003. "Incentive Compatibility And Pricing Under Moral Hazard," Economics Working Papers we035722, Universidad Carlos III, Departamento de Economía.
  2. Bel? Jerez, 2001. "A Dual Characterization of Incentive Efficiency," UFAE and IAE Working Papers 494.01, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).

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