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Kahn, C. M. and D. Mookherjee (1995). 'Market failure with moral hazard and side trading'. Journal of Public Economics 58(2): 159.
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Full-information insurance markets are compared with
- markets where accident-reducing effort levels are unverifiable but trades between every pair of agents are verifiable and
- markets where neither effort nor trades are verifiable.
Markets are represented by a contracting game, with a solution concept allowing coordination among coalitions through information-constrained contracts. Each informational setting yields a correspondence between market outcomes and the appropriate notion of constrained efficiency in a social planner's problem. Although incentive externalities do not cause market outcomes to be constrained inefficient, they do imply a welfare gain from public verifiability of trades.
