Chapter 6 Signaling games and refinements 6.1 Adverse selection The term adverse selection comes originally from insurance applications. An insurance contract may attract high-risk individuals, with the result that the pool of insured customers may be riskier than the population at large Adverse selection is now used generically to describe situations of asymmet ric information, particularly market settings in which some individuals have private information about their characteristics and where the individuals actions may reveal some or all of that information to other individuals. The earliest work on adverse selection(Akerlof(1969), Spence(1973)made use of the competitive equilibrium framework. Later we shall want to make use of this framework, but to start with we will use a simple game-theoretic framework to develop the basic insights A signaling game is played between a single informed agent and two or more risk-neutral uninformed agents. The informed agent undertakes a risk venture which he then sells to the uninformed agents. The agent's private information is represented by his type t E T, where T is a finite set. The probability of the informed agent's type is v(t). The agent chooses an action a E A, where A is a finite set. The agent's action is publically observed. The extensive form game has three stages Nature chooses the informed agent's type tChapter 6 Signaling games and refinements 6.1 Adverse selection The term adverse selection comes originally from insurance applications. An insurance contract may attract high-risk individuals, with the result that the pool of insured customers may be riskier than the population at large. Adverse selection is now used generically to describe situations of asymmet￾ric information, particularly market settings in which some individuals have private information about their characteristics and where the individuals’ actions may reveal some or all of that information to other individuals. The earliest work on adverse selection (Akerlof (1969), Spence (1973)) made use of the competitive equilibrium framework. Later we shall want to make use of this framework, but to start with we will use a simple game-theoretic framework to develop the basic insights. A signaling game is played between a single informed agent and two or more risk-neutral uninformed agents. The informed agent undertakes a risky venture which he then sells to the uninformed agents. The agent’s private information is represented by his type t ∈ T, where T is a finite set. The probability of the informed agent’s type is ν(t). The agent chooses an action a ∈ A, where A is a finite set. The agent’s action is publically observed. The extensive form game has three stages: • Nature chooses the informed agent’s type t. 1