Michael Rothschild, Distinguished Fellow 2005
At the end of the 1960s, general equilibrium theory was dominant and most economic theorists referred to themselves as mathematical economists. Within a few years, however, a new generation emerged, applying sophisticated and rigorous techniques directed to a new set of problems and employing small models. Michael Rothschild was a trailblazer in these developments. His work quickly became a model for the new style of theorizing and it remains highly influential to this day. A leading example is his work with Joseph Stiglitz on increasing risk, which provided three plausible definitions of what it means for one random variable to be riskier than another. They showed that the three are equivalent but that none is the same as "having a higher variance." Soon legions of economists were following their lead.
Many of Rothschild's most important contributions lie in the area of information economics. One issue of longstanding interest is why a single homogeneous good can sell at different prices. The early literature analyzed this problem with models of consumer search. Rothschild showed that the well-known reservation price rule from that literature extends to the case where consumers do not know the distribution of prices. In his famous two-armed bandit treatise, he showed that a firm that does not know its demand curve, yet optimally experiments, may end up charging the "wrong" price and may never learn from its mistakes.
Rothschild's most notable contribution to information economics is his paper with Stiglitz on insurance markets. Prior to this work, it was known that adverse selection could cause market failure and lead to costly signaling. But no one had developed a full model of market equilibrium. Rothschild and Stiglitz did so by studying an insurance market in which uninformed insurance companies screen individuals by offering different types of insurance contracts. They showed that a standard Nash equilibrium may fail to exist and that, when an equilibrium does exist, it may be inefficient. This paper inspired a large number of theoretical extensions and has stimulated important empirical work in recent years.
In the next stage of his career, Rothschild chose a different direction, moving into university administration after periods at Harvard University, Princeton University, the University of Wisconsin-Madison, and the University of California, San Diego (UCSD). He served as Dean of Social Sciences at UCSD and then as Dean of the Woodrow Wilson School of Public and International Affairs at Princeton, where he spearheaded reform and gave strong support to research. Rothschild continued to conduct research during this time on arbitrage, asset pricing, and the economics of education. He also accumulated a small, but loyal, group of graduate students who remain deeply grateful for his mentoring.
As a scholar, Rothschild is insightful, deep, erudite, and eloquent. He is also a man of great wit. What other economist would write, "I apologize to any author who feels the very essence of his work has been distorted by the Procrustean bed of this essay's logical development?"