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Decentralizing Incentive Efficient Allocations of Economies with Adverse Selection

Author

Listed:
  • 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.

Suggested Citation

  • Alberto Bisin & Piero Gottardi, 2000. "Decentralizing Incentive Efficient Allocations of Economies with Adverse Selection," Econometric Society World Congress 2000 Contributed Papers 0855, Econometric Society.
  • Handle: RePEc:ecm:wc2000:0855
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    References listed on IDEAS

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    2. Belen Jerez, 2005. "Incentive Compatibility and Pricing under Moral Hazard," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(1), pages 28-47, January.

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