CFDP 1305

Signalling and Default: Rothschild-Stiglitz Reconsidered

Author(s): 

Publication Date: May 2001

Pages: 28

Abstract: 

In our previous paper we built a general equilibrium model of default and punishment in which equilibrium always exists and endogenously determines asset promises, penalties, and sales constraints. In this paper we interpret the endogenous sales constraints as equilibrium signals. By specializing the default penalties and imposing an exclusivity constraint on asset sales, we obtain a perfectly competitive version of the Rothschild-Stiglitz model of insurance. In our model their separating equilibrium always exists even when they say it doesn’t.

Keywords: 

Default, incomplete markets, adverse selection, moral hazard, equilibrium refinement, signalling, endogenous assets

JEL Classification Codes:  D4, D5, D41, D52, D81, D81