A Game Theoretic Foundation of Competitive Equilibria with Adverse Selection
AbstractWe construct a fully specified extensive form game that captures competitive markets with adverse selection. In particular, it allows firms to offer any finite set of contracts, so that cross-subsidization is not ruled out. Moreover, firms can withdraw from the market after initial contract offers have been observed. We show that a subgame perfect equilibrium always exists and that, in fact, when withdrawal is costless, the set of subgame perfect equilibrium outcomes may correspond to the entire set of feasible contracts. We then focus on robust equilibria that exist both when withdrawal costs are zero and when they are arbitrarily small but strictly positive. We show that the Miyazaki-Wilson contracts are the unique robust equilibrium outcome of our game. This outcome is always constrained efficient and involves cross-subsidization from low to high risk agents that is increasing in the share of low risks in the population under weak conditions on risk preferences.
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Date of creation: Oct 2012
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Find related papers by JEL classification:
- C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
- D02 - Microeconomics - - General - - - Institutions: Design, Formation, and Operations
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
- H1 - Public Economics - - Structure and Scope of Government
- L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-10-27 (All new papers)
- NEP-BEC-2012-10-27 (Business Economics)
- NEP-COM-2012-10-27 (Industrial Competition)
- NEP-CTA-2012-10-27 (Contract Theory & Applications)
- NEP-GTH-2012-10-27 (Game Theory)
- NEP-MIC-2012-10-27 (Microeconomics)
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- Theodoros M. Diasakos & Kostas Koufopoulos, 2011.
"Efficient Nash Equilibrium under Adverse Selection,"
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215, Collegio Carlo Alberto.
- Theodoros M. Diasakos & Kostas Koufopoulos, . "Efficient Nash Equilibrium under Adverse Selection," Discussion Paper Series, Department of Economics 201313, Department of Economics, University of St. Andrews.
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