(Neutrally) Optimal Mechanism under Adverse Selection: The canonical insurance problem

TY - JOUR

T1 - (Neutrally) Optimal Mechanism under Adverse Selection

T2 - The canonical insurance problem

AU - Diasakos, Theodoros

AU - Koufopoulos, Konstantinos

N1 - ©2018 Elsevier Inc. All rights reserved. This is an author-produced version of the published paper. Uploaded in accordance with the publisher’s self-archiving policy. Further copying may not be permitted; contact the publisher for details.

PY - 2018/9

Y1 - 2018/9

N2 - This paper revisits the problem of adverse selection in the insurance market of Rothschild and Stiglitz(1976). We extend the three-stage game in Hellwig(1987)by allowing firms to endogenously choose whether or not to pre-commit on their contractual offers (menus). We show how this mechanism can deliver the Miyazaki–Wilson–Spence allocation as the unique perfect-Bayesian equilibrium. This allocation is the unique incentive-efficient and individually-rational maximizer of the utility of the most profitable type. In fact, given that the informed player has only two types, it is the unique core allocation and thus the unique neutral optimum in the sense of Myerson(1983).

AB - This paper revisits the problem of adverse selection in the insurance market of Rothschild and Stiglitz(1976). We extend the three-stage game in Hellwig(1987)by allowing firms to endogenously choose whether or not to pre-commit on their contractual offers (menus). We show how this mechanism can deliver the Miyazaki–Wilson–Spence allocation as the unique perfect-Bayesian equilibrium. This allocation is the unique incentive-efficient and individually-rational maximizer of the utility of the most profitable type. In fact, given that the informed player has only two types, it is the unique core allocation and thus the unique neutral optimum in the sense of Myerson(1983).

KW - Insurance market

KW - Adverse selection

KW - Interim incentive efficiency

KW - Neutral optimum

U2 - 10.1016/j.geb.2018.04.007

DO - 10.1016/j.geb.2018.04.007

M3 - Article

VL - 111

SP - 159

EP - 186

JO - Games and Economic Behaviour

JF - Games and Economic Behaviour

SN - 0899-8256

ER -