Optimal Contract Regulation in Selection Markets

54 Pages Posted: 9 Feb 2022 Last revised: 6 May 2022

See all articles by Andre Veiga

Andre Veiga

Imperial College London

Yehuda Levy

Adam Smith Business School

Date Written: February 8, 2022


Abstract We develop a tractable model of competitive insurance markets with a continuum of types and exogenous restrictions on the set of allowed contracts. Our model nests, as special cases, the market for lemons of Akerlof (1970) and the unrestricted contracts setting of Rothschild and Stiglitz (1976). We allow purchase to be mandatory or voluntary. Equilibrium generically exhibits partial pooling and therefore depends non-trivially on the type distribution. An increase in the maximal allowed coverage always increases welfare. Increases in the minimal allowed coverage have ambiguous (and possibly non-monotonic) effects on welfare. In markets for lemons, if the first best is not an equilibrium, then the socially optimal level of mandated coverage is interior (i.e, below full insurance).

Keywords: Adverse Selection, Asymmetric Information, Insurance, Equilibrium Existence, Regulation

JEL Classification: C62, G22, I13, D82, L51

Suggested Citation

Veiga, Andre and Levy, Yehuda, Optimal Contract Regulation in Selection Markets (February 8, 2022). Available at SSRN: https://ssrn.com/abstract=4029945 or http://dx.doi.org/10.2139/ssrn.4029945

Andre Veiga (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Yehuda Levy

Adam Smith Business School ( email )

Glasgow, Scotland
United Kingdom

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