Nonlinear Incentive Contracting in Walrasian Markets: A Cournot Approach

Martin Hellwig

No 00-42, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim, Sonderforschungsbereich 504, University of Mannheim

Abstract: The paper studies insurance with moral hazard in the context of a Walrasian system of contingent-claims markets. The insurance buyer is modelled as a Cournot monopolist. Price-taking agents condition their expectations on market prices, as in models of rational-expectations equilibrium with asymmetric information. Thereby they correctly anticipate the accident probabilities that are associated with the different possible choices of the insurance buyer's net trades as these trades affect effort incentives. When there are many agents to share the insurance buyers risk, Cournot equilibrium outcomes are close to being second-best and close to outcomes under efficient bilateral contracting with risk neutral insurers. In contrast, if the insurance buyer is a price taker, equilibria are bounded away from being second-best or fail to exist.

Pages: 37 pages
Date: 2000-09-11
Note: This paper owes a lot to discussions that I have had over the years with Richard Arnott, Tilman Börgers, Winand Emons, Laurenz Kohlleppel, Joe Stiglitz, Thomas von Ungern-Sternberg, and especially Douglas Gale. I am grateful to all of them. I am also grateful for research support from the Deutsche Forschungsgemeinschaft through Sonderforschungsbereich 504 at the University of Mannheim.
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