This thesis modifies the Rothschild and Stiglitz model [1977]. We incorporate various forms of transaction costs, which are modeled as a fixed per policy fee plus variable costs as being proportional to the premium or indemnity amount. These three forms of transaction costs bring distinct consequences to insurance buyers' behavior. Under Rothschild and Stiglitz's framework, there will be no pooling equilibrium for any form of transaction costs. We will see a new separating equilibrium if the cost function contains a term proportional to the reimbursement amount. In this case, neither high-risk individuals nor low-risk individuals cause any externality to the other group in the market. It is demonstrated in this thesis, under fairly normal conditions, the standard result in the analysis of insurance market under adverse selection could be reversed.
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