Predetermined Prices and the Allocation of Social Risks

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Abstract
We propose a Walrasian explanation for the existence of fixed prices, i.e., of trades in which either the price or the quantity exchanged does not reflect all publicly available information. Such trades result in a rigid price system that facilitates the sharing of social risks; they may also cause allocative distortions that increase the equilibrium price of insurance above its actuarially fair level. We demonstrate that the market for noncontingent claims is active only when this insurance “gain” outweighs the “cost” of allocative distortions. Fixed price equilibria are constrained optima, i.e., they cannot be dominated by an appropriately constrained central planner.

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