Working Paper: CEPR ID: DP2269
Authors: Roman Inderst; Achim Wambach
Abstract: Ever since the seminal work by Rothschild and Stiglitz (1976) on competitive insurance markets under adverse selection the equilibrium-non-existence problem has been one of the major puzzles in insurance economics.We extend the original analysis by considering firms that face capacity constraints due to limited capital. Two scenarios are considered: if the demand at any insurer exceeds the capacity: either consumers are rationed, or they are served, but the insurer faces a larger risk of bankruptcy. We show under mild assumptions that a pure strategy equilibrium exists, where every consumer buys his appropriate Rothschild-Stiglitz contract.
Keywords: insurance markets; asymmetric information; competitive equilibrium; capacity constraints
JEL Codes: C72; C78; D82; G22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Introducing capacity constraints (D24) | Stabilizes Rothschild-Stiglitz contracts (D52) |
| Capacity constraints (D24) | Alters dynamics leading to nonexistence of equilibrium in Rothschild-Stiglitz model (D59) |
| Deviating firm offering new contracts (L14) | Does not attract fair mix of risk types (G40) |
| Rationing due to capacity constraints (D45) | High-risk types dominate applications (C46) |
| High-risk types dominating applications (C46) | Unprofitable for firm to deviate (L21) |
| Unprofitable for firm to deviate (L21) | Original contracts remain stable (D86) |