Endogenous Commitment and Nash Equilibria in Competitive Markets with Adverse Selection

Economics

Speaker:Kostas Koufopoulos, University of Warwick
Date: Wednesday 23 November 2011
Time: 16:15
Location: STC/D

Further details

In this paper, we provide a unified framework for analyzing competitive markets with adverse selection. The key feature of our model is that whether the firms (uninformed) are committed to the contracts they offer or not is determined endogenously. Due to endogenous commitment, our model always has a unique Bayes-Nash equilibrium without using any refinement to restrict beliefs off-the-equilibrium path. This feature makes our approach very useful for applied theory papers where usually the uniqueness of the equilibrium is crucial for the model’s empirical relevance and testability. We also show that both the non-existence problem in the two-stage screening games and the multiplicity of equilibria in the three-stage screening and the signalling games are due to exogenous full commitment (non-existence) and exogenous lack of commitment (multiplicity). Finally, we provide a rationale for the widely observed fact that banks, insurance companies and many non-financial firms keep the right to reject applications for (some of) the contracts they offer.