(Neutrally) Optimal Mechanism Under Adverse Selection: The Canonical Insurance Problem

68 Pages Posted: 27 Oct 2015

See all articles by Theodoros Diasakos

Theodoros Diasakos

University of Stirling - Department of Economics

Kostas Koufopoulos

University of Warwick - Finance Group

Date Written: October 26, 2015

Abstract

This paper revisits the problem of adverse selection in the insurance market of Rothschild and Stiglitz. We extend the game-theoretic structure in Hellwig to a mechanism in which the Miyazaki-Wilson-Spence allocation is the unique perfect-Bayesian equilibrium. As is well-known, this allocation is the unique incentive-efficient and individually-rational maximizer of the utility of the 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.

Keywords: Insurance Market, Adverse Selection, Interim Incentive Efficiency, Neutral Optimum

JEL Classification: D86

Suggested Citation

Diasakos, Theodoros and Koufopoulos, Kostas, (Neutrally) Optimal Mechanism Under Adverse Selection: The Canonical Insurance Problem (October 26, 2015). Available at SSRN: https://ssrn.com/abstract=2680295 or http://dx.doi.org/10.2139/ssrn.2680295

Theodoros Diasakos (Contact Author)

University of Stirling - Department of Economics ( email )

Stirling, FK9 4LA
United Kingdom

Kostas Koufopoulos

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

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