1. Describe a separating equilibrium in the Rothschild-Stiglitz model with perfect information. 2. Describe a separating equilibrium in the Rothschild-Stiglitz model with asymmetric information.
1. Describe a separating equilibrium in the Rothschild-Stiglitz model with perfect information.
2. Describe a separating equilibrium in the Rothschild-Stiglitz model with asymmetric information.
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In the separating equilibrium of the Rothschild-Stiglitz insurance market model, uncertainty, pessimism, or more risk aversion on the part of high risk consumers benefit low risk consumers who are not fully insured. The self-selection equilibrium was defined by Rothschild-Stiglitz under the assumption of exclusivity, which requires complete transparency of contracts purchased. Low-risk individuals purchase little insurance in insurance markets; with perfect information, they would have purchased full coverage. When the distortion caused by self-selection becomes too great, a pooling contract bought by high and low risk persons is always chosen, and the "separating" equilibrium cannot be maintained. There is no competitive equilibrium in this scenario.
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