Efficient Competitive Equilibria with Adverse Selection

By Alberto Bisin, P. Gottardi. Journal of Political Economy, 2006

190 citations recorded by the source corpus.

Do Walrasian markets function orderly in the presence of adverse selection? In particular, is their outcome efficient when exclusive contracts are enforceable? This paper addresses these questions in the context of a Rothschild‐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 competitive equilibria always exist but are not typically incentive efficient. However, as markets for pollution rights can internalize environmental externalities, markets for consumption rights can be designed to internalize the consumption externality due to adverse selection. With such markets competitive equilibria exist and incentive‐constrained versions of the first and second welfare theorems hold.

Subfields: Accounting, Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/507303e6829a54d51761bc93d392d40d72f709e2

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Citations in the corpus

Leverage Cycles and the Anxious Economy (2008, background): “We are ready to explain inequality (5)”
Asset commonality, debt maturity and systemic risk. (2012, background): “However, as banks cannot observe the linkages 27 of the other banks, exclusive contracting in linkage formation is not possible in our model (see, e.g., Bisin and Gottardi, 2006; Bizer and De Marzo, 1992).”