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Efficient Competitive Equilibria with Adverse Selection

  • Alberto Bisin
  • Piero Gottardi

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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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2005/wp-cesifo-2005-07/cesifo1_wp1504.pdf
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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. Ledyard, John O. & Szakaly-Moore, Kristin, 1994. "Designing organizations for trading pollution rights," Journal of Economic Behavior & Organization, Elsevier, vol. 25(2), pages 167-196, October.
  2. 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).
  3. Douglas Gale, 1996. "Equilibria and Pareto optima of markets with adverse selection (*)," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 7(2), pages 207-235.
  4. Crocker, Keith J. & Snow, Arthur, 1985. "The efficiency of competitive equilibria in insurance markets with asymmetric information," Journal of Public Economics, Elsevier, vol. 26(2), pages 207-219, March.
  5. John H. Boyd & Edward C. Prescott & Bruce D. Smith, 1988. "Organizations in economic analysis," Working Papers 385, Federal Reserve Bank of Minneapolis.
  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. 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.
  8. Prescott, Edward C & Townsend, Robert M, 1984. "General Competitive Analysis in an Economy with Private Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 1-20, February.
  9. Bisin, Alberto & Gottardi, Piero, 1999. "Competitive Equilibria with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 87(1), pages 1-48, July.
  10. Hellwig,Martin, 1986. "Some recent developments in the theory of competition in markets with adverse selection," Discussion Paper Serie A 82, University of Bonn, Germany.
  11. Alberto Bennardo & Pierre-Andre Chiappori, 2003. "Bertrand and Walras Equilibria Under Moral Hazard," Levine's Working Paper Archive 618897000000000748, David K. Levine.
  12. V. V. Chari & Larry E. Jones, 1991. "A reconsideration of the problem of social cost: free riders and monopolists," Staff Report 142, Federal Reserve Bank of Minneapolis.
  13. Kehoe, Timothy J. & Levine, David K. & Prescott, Edward C., 2002. "Lotteries, Sunspots, and Incentive Constraints," Journal of Economic Theory, Elsevier, vol. 107(1), pages 39-69, November.
  14. Alberto Bisin & Piero Gottardi, 2006. "Efficient Competitive Equilibria with Adverse Selection," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 485-516, June.
  15. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-59, March.
  16. 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.
  17. Douglas Gale, 1992. "A Walrasian Theory of Markets with Adverse Selection," Review of Economic Studies, Oxford University Press, vol. 59(2), pages 229-255.
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