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

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JournalGames and Economic Behaviour
DateE-pub ahead of print - 28 May 2018
DatePublished (current) - Sep 2018
Volume111
Number of pages28
Pages (from-to)159–186
Early online date28/05/18
Original languageEnglish

Abstract

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).

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©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.

    Research areas

  • Insurance market, Adverse selection, Interim incentive efficiency, Neutral optimum

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