Efficient competitive equilibria with adverse selection

Alberto Bisin, Piero Gottardi

    Research output: Contribution to journalArticlepeer-review

    Abstract

    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.

    Original languageEnglish (US)
    Pages (from-to)485-516
    Number of pages32
    JournalJournal of Political Economy
    Volume114
    Issue number3
    DOIs
    StatePublished - Jun 2006

    ASJC Scopus subject areas

    • Economics and Econometrics

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