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A Game Theoretic Foundation of Competitive Equilibria with Adverse Selection

Listed author(s):
  • Nick Netzer
  • Florian Scheuer

We 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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File URL: http://www.nber.org/papers/w18471.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18471.

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Date of creation: Oct 2012
Publication status: published as Nick Netzer & Florian Scheuer, 2014. "A Game Theoretic Foundation Of Competitive Equilibria With Adverse Selection," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 55, pages 399-422, 05.
Handle: RePEc:nbr:nberwo:18471
Note: EFG IO PE
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