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Endogenous Insolvency in the Rothschild–Stiglitz Model

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  • Wanda Mimra
  • Achim Wambach

Abstract

Even 30 years after Rothschild and Stiglitz's () seminal work on competitive insurance markets with adverse selection, existence and characterization of the equilibrium outcome are still an open issue. We model a basic extension to the Rothschild and Stiglitz () model: we endogenize up‐front capital of insurers. Under limited liability, low up‐front capital gives rise to an aggregate endogenous insolvency risk, which introduces an externality among customers of an insurer (Faynzilberg, 2006). It is shown that an equilibrium with the second‐best efficient Miyazaki–Wilson–Spence allocation always exists.

Suggested Citation

  • Wanda Mimra & Achim Wambach, 2019. "Endogenous Insolvency in the Rothschild–Stiglitz Model," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 86(1), pages 165-181, March.
    • Handle: RePEc:bla:jrinsu:v:86:y:2019:i:1:p:165-181
    DOI: 10.1111/jori.12206
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    Cited by:

    1. Gemmo, Irina & Kubitza, Christian & Rothschild, Casey, 2020. "Constrained efficient equilibria in selection markets with continuous types," Journal of Public Economics, Elsevier, vol. 190(C).
    2. Hui Li & Seth Neumuller & Casey Rothschild, 2021. "Optimal annuitization with imperfect information about insolvency risk," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(1), pages 101-130, March.
    3. Yuechen Dai & Richard Watt, 2023. "Adverse Selection with the Boot on the Other Foot: Insurer Insolvency as a Problem in Asymmetric Information," Working Papers in Economics 23/02, University of Canterbury, Department of Economics and Finance.

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