Incentive Compatibility and Pricing under Moral Hazard

Belén Jerez

Review of Economic Dynamics, 2005, vol. 8, issue 1, 28-47

Abstract: We show how to recover equilibrium prices supporting incentive efficient allocations in a classic insurance economy with moral hazard. Our key modeling choice is to impose the incentive compatibility constraints on insurance firms, and not on consumers as in Prescott and Townsend (1984). We show that equilibrium prices of insurance contracts are equal to the sum of the shadow costs arising from the resource and incentive compatibility constraints in the planner's problem. The equilibrium allocations are the same as when the incentive compatibility constraints are imposed on consumers. As in Prescott and Townsend, the two welfare theorems hold. (Copyright: Elsevier)

Date: 2005
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DOI: 10.1016/j.red.2004.10.005

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