General equilibrium in economies with adverse selection

We model economies of adverse selection as Arrow–Debreu economies. In the spirit of Prescott and Townsend (Econometrica 52(1), 21–45, 1984a), we identify the consumption set of the individuals with the set of lotteries over net transfers. Thus, prices are linear in lotteries, but they may be non linear in commodity bundles. First, we study a weak equilibrium notion by viewing the economy of adverse selection as a pure exchange economy. The weak equilibrium set is non empty, but some of the allocations may be inefficient, and the equilibria indeterminate. Second, following Prescott and Townsend (Econometrica 52(1), 21–45, 1984a), we introduce an intermediary (firm) supplying feasible and incentive compatible measures. Equilibria are constrained efficient, but the equilibrium set is empty for an open set of economies containing the Rothschild and Stiglitz insurance economies. The research of A. Rustichini was supported by the NSF grant NSF/SES-0136556.