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Negative Externalities and Equilibrium Existence in Competitive Markets with Adverse Selection

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Author Info
von Siemens, Ferdinand () (University of Amsterdam)
Kosfeld, Michael () (Goethe University Frankfurt)

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Abstract

Rothschild and Stiglitz (1976) show that there need not exist a competitive equilibrium in markets with adverse selection. Building on their framework we demonstrate that externalities between agents − an agent's utility upon accepting a contract depends on the average type attracted by the respective principal − can solve the equilibrium existence problem, even when the size of the externalities is arbitrarily small. Our result highlights the degree of control a principal has over the attractiveness of his contracts as an important feature for equilibrium existence, thereby offering a new perspective on existing theories of competition in markets with adverse selection.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4125.

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Length: 22 pages
Date of creation: Apr 2009
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Handle: RePEc:iza:izadps:dp4125

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Related research
Keywords: asymmetric information; competition; adverse selection; externality;

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Dalmazzo, Alberto, 2002. " Technological Complexity, Wage Differentials and Unemployment," Scandinavian Journal of Economics, Blackwell Publishing, vol. 104(4), pages 515-30, December. [Downloadable!] (restricted)
  2. Pradeep Dubey & John Geanakoplos, 2001. "Competitive Pooling: Rothschild-Stiglitz Reconsidered," Cowles Foundation Discussion Papers 1346R2, Cowles Foundation, Yale University, revised Feb 2002. [Downloadable!]
  3. Gale, Douglas, 1992. "A Walrasian Theory of Markets with Adverse Selection," Review of Economic Studies, Blackwell Publishing, vol. 59(2), pages 229-55, April. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
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  5. 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.
  6. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-59, March. [Downloadable!] (restricted)
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  7. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September. [Downloadable!] (restricted)
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