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Competitive Insurance Markets with Two Unobservables

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  • Michael Smart

Abstract

We study a screening game in a competitive insurance market, in which insurance customers differ with respect to both accident probability and degree of risk aversion. It is shown that indifference curves of customers in different risk classes cross exactly twice: thus the single crossing property does not hold. The existence of a unique reactive equilibrium is demonstrated. This equilibrium may be markedly different from the Pareto-dominant separating equilibrium that exists when single crossing holds. In particular, types may be pooled in equilibrium, so that cross-subsidization occurs. Moreover, insurance firms can earn positive expected profit in equilibrium, despite the usual assumption of Bertrand-like price-competition among firms. We study the implications of the model for the efficiency of market equilibrium and for the effects of rate-of-return regulation of insurance firms.

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File URL: http://www.economics.utoronto.ca/public/workingPapers/UT-ECIPA-MSMART-96-01.ps
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File URL: http://www.economics.utoronto.ca/public/workingPapers/UT-ECIPA-MSMART-96-01.pdf
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Bibliographic Info

Paper provided by University of Toronto, Department of Economics in its series Working Papers with number msmart-96-01.

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Length: 22 pages
Date of creation: 12 Mar 1996
Date of revision:
Handle: RePEc:tor:tecipa:msmart-96-01

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  1. Laffont, Jean-Jacques & Rochet, Jean-Charles, 1988. " Stock Market Portfolios and the Segmentation of the Insurance Market," Scandinavian Journal of Economics, Wiley Blackwell, vol. 90(3), pages 435-46.
  2. Bagwell, Laurie Simon & Bernheim, B Douglas, 1996. "Veblen Effects in a Theory of Conspicuous Consumption," American Economic Review, American Economic Association, vol. 86(3), pages 349-73, June.
  3. In-Koo Cho & David M. Kreps, 1997. "Signaling Games and Stable Equilibria," Levine's Working Paper Archive 896, David K. Levine.
  4. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
  5. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
  6. John G. Riley, 1976. "Informational Equilibrium," UCLA Economics Working Papers 071, UCLA Department of Economics.
  7. Roger B. Myerson, 1981. "Mechanism Design by an Informed Principal," Discussion Papers 481, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. 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.
  9. Landsberger Michael & Meilijson Isaac, 1994. "Monopoly Insurance under Adverse Selection When Agents Differ in Risk Aversion," Journal of Economic Theory, Elsevier, vol. 63(2), pages 392-407, August.
  10. Quinzii, Martine & Rochet, Jean-Charles, 1985. "Multidimensional signalling," Journal of Mathematical Economics, Elsevier, vol. 14(3), pages 261-284, June.
  11. Engers, Maxim & Fernandez, Luis F, 1987. "Market Equilibrium with Hidden Knowledge and Self-selection," Econometrica, Econometric Society, vol. 55(2), pages 425-39, March.
  12. Engers, Maxim, 1987. "Signalling with Many Signals," Econometrica, Econometric Society, vol. 55(3), pages 663-74, May.
  13. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
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