This paper reverses the standard conclusion that asymmetric information plus competition results in insu cient insurance provision. Risk-tolerant individuals take few precautions and are disinclined to insure, but are drawn into a pooling equilibrium by the low premiums createdbythepresence of safer, more risk-averse types. Taxing insurance drives out the reckless clients, allowing a strict Pareto gain. This result depends on administrative costs in processing claims and issuing policies, as does the novel nding of a pure-strategy, partial-pooling, sub-game-perfect, Nash equilibrium in the insurance market. We would like to thank Heskey Bar-Issac, John Black, George Bulkley, Konstantinos Koufopoulos and especially the Editor Lars Stole and two referees for exceptionally helpful comments. Wewould also like to thank seminar participants at Universities of Bologna, Bocconi, Edinbugh, Exeter, Oxford, CEMFI, LSE and EARIE 2000 for useful discussions.
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A mass of evidence suggests that aspiring entrepreneurs with low net worth or from disadvantaged social groups are excluded from capital markets. Asymmetric information potentially explains these findings, though whether aggregate lending is raised or lowered relative to the full information outcome is ambiguous. Whichever case occurs, subsidising credit may decrease efficiency. This is all the more true when, as the evidence suggests, potential entrepreneurs are prone to unrealistic optimism. Indeed, even though optimism may cause redlining and credit rationing and so lower lending, the case for policies to encourage lending is further undermined.
Identical cases of wine are often auctioned one immediately after another. Ashenfelter (1989) reports that on average, the later lots fetch less. Such a systematic price difference seems anomalous, the more so because it is shown here that rational expectations imply not equal, but rising, prices. Risk aversion is an obvious way of reconciling the evidence with rational behavior. There is an alternative explanation. The auctions observed by Ashenfelter involved a buyer's option, whereby the first‐round winner could purchase further cases at the same price. It is shown that this feature may both account for the observed price trajectory and raise seller revenue.
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