Working Paper: NBER ID: w18471
Authors: Nick Netzer; Florian Scheuer
Abstract: We construct a fully specified extensive form game that captures competitive markets with adverse selection. In particular, it allows firms to offer any finite set of contracts, so that cross-subsidization is not ruled out. Moreover, firms can withdraw from the market after initial contract offers have been observed. We show that a subgame perfect equilibrium always exists and that, in fact, when withdrawal is costless, the set of subgame perfect equilibrium outcomes may correspond to the entire set of feasible contracts. We then focus on robust equilibria that exist both when withdrawal costs are zero and when they are arbitrarily small but strictly positive. We show that the Miyazaki-Wilson contracts are the unique robust equilibrium outcome of our game. This outcome is always constrained efficient and involves cross-subsidization from low to high risk agents that is increasing in the share of low risks in the population under weak conditions on risk preferences.
Keywords: adverse selection; competitive equilibria; game theory; Miyazaki-Wilson contracts
JEL Codes: C73; D82; D86; G22; H1; L1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Miyazaki-Wilson contracts (D86) | unique robust equilibrium outcome (C62) |
| withdrawal costs (J32) | existence of single SPE outcome (C20) |
| share of low-risk agents (L85) | cross-subsidization from low-risk to high-risk agents (G22) |
| contract offerings and market behavior (L14) | equilibrium outcomes (D51) |