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Negative Externalities and Equilibrium Existence in Competitive Markets with Adverse Selection

Author

Listed:
  • von Siemens, Ferdinand

    (Goethe University Frankfurt)

  • Kosfeld, Michael

    (Goethe University Frankfurt)

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.

Suggested Citation

  • von Siemens, Ferdinand & Kosfeld, Michael, 2009. "Negative Externalities and Equilibrium Existence in Competitive Markets with Adverse Selection," IZA Discussion Papers 4125, IZA Network @ LISER.
    • Handle: RePEc:iza:izadps:dp4125
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    References listed on IDEAS

    as
    1. Douglas Gale, 1992. "A Walrasian Theory of Markets with Adverse Selection," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(2), pages 229-255.
    2. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 629-649.
    3. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-359, March.
    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.
    5. Charles I. Jones, 2008. "Intermediate Goods, Weak Links, and Superstars: A Theory of Economic Development," NBER Working Papers 13834, National Bureau of Economic Research, Inc.
    6. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
    7. In-Koo Cho & David M. Kreps, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(2), pages 179-221.
    8. repec:bla:scandj:v:104:y:2002:i:4:p:515-30 is not listed on IDEAS
    9. Pradeep Dubey & John Geanakoplos, 2002. "Competitive Pooling: Rothschild-Stiglitz Reconsidered," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(4), pages 1529-1570.
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    Cited by:

    1. Theodoros M. Diasakos & Kostas Koufopoulos, 2011. "Efficient Nash Equilibrium under Adverse Selection," Carlo Alberto Notebooks 215, Collegio Carlo Alberto.
    2. Diasakos, Theodoros M. & Koufopoulos, Kostas, 2018. "(Neutrally) Optimal Mechanism under Adverse Selection: The canonical insurance problem," Games and Economic Behavior, Elsevier, vol. 111(C), pages 159-186.

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    More about this item

    Keywords

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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