An evolutionary analysis of insurance markets with adverse selection

Rothschild and Stiglitz (1976) demonstrated that adverse selection may entail nonexistence of equilibrium in competitive insurance markets. We approach this problem in a dynamic model with boundedly rational insurance rms. Firms' behavior is based on imitation of pro t making contracts, withdrawal of loss making contracts, and experimentation with random contracts. Consumers choose in each period the best contract available. We show that the candidate competitive equilibrium is the long run prediction if experimentation is rare and every rm experiments with contracts in the vicinity of its current menu. JEL classi cation: C70, C72, D82, G22, L1