Adverse Selection, Dissembling, and Competitive Equilibrium

Rothschild and Stiglitz have shown than insurance markets and other markets in which an adverse-selection problem exists cannot have Nash-type pooling or subsidized separating equilibria and are unlikely to have Nash-type unsubsidized separating equilibria. Wilson, Miyazaki, and Riley have analyzed anticipatory pooling and subsidized-separating equilibria and reactive unsubsidized separating equilibria. Each of these alternatives to Nash-type equilibria requires strategic behavior on the part of insurance sellers for support. The present paper analyzes as another alternative pooling equilibria that require dissembling behavior on the part of insurance buyers for support. This dissembling model has the attractive feature that it takes explicit account of the convention of requiring insurance buyers to submit applications, a practice that the analysis interprets to be a natural response to the adverse-selection problem.