Characterization, Existence, and Pareto Optimality in Markets with Asymmetric Information and Endogenous and Asymmetric Disclosures : Basic Analytics of Revisiting Rothschild-Stiglitz

We study the Rothschild-Stiglitz model of insurance markets, introducing endogenous information disclosure about insurance sales and purchases by firms and consumers. We show that a competitive equilibrium exists under unusually mild conditions, and characterize the unique equilibrium outcome. With two types of consumers the outcome is particularly simple, consisting of a pooling contract which maximizes the well-being of the low risk individual (along the zero profit pooling line) plus a supplemental (undisclosed and nonexclusive) contract that brings the high risk individual to full insurance (at his own odds). We show that this outcome is extremely robust and constrained Pareto efficient. Asymmetric equilibrium information flows with endogenous consumer disclosure are critical in supporting the equilibrium.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at "http://www.nber.org/papers/w26251"