RENEGOTIATION-PROOF LOTTERIES EQUILIBRIUM IN AN ECONOMY WITH PRIVATE INFORMATION

The purpose of this paper is to explore whether the standard results o f classical general equilibrium theory still hold in private informati on economies where the possibility of renegotiation of initial contrac ts (lotteries) is allowed. We establish that competitive equilibria wi th contracts (lotteries) exist and are optimal for the class of privat e information economies in which principal-agent problems are characte rized by moral hazard and renegotiation-proof contracts (lotteries). W e also show that financial intermediaries arise endogenously in this e nvironment: financial intermediaries are part of an efficient arrangem ent which is needed to support the competitive equilibrium allocations of our private information economy. (C) 1995 Academic Press, Inc.