Capacity constrained firms in (labor) markets with adverse selection

Summary. We discuss a competitive (labor) market where firms face capacity constraints and individuals differ according to their productivity. Firms offer two-dimensional contracts like wage and task level. Then workers choose firms and contracts. Workers might be rationed if the number of applicants exceeds the capacity of the firm. We show that under reasonable assumptions on the distribution of capacity an equilibrium in pure strategies (by the firms) exists. This result stands in contrast to the case of unlimited capacity. The utility level is uniquely determined in equilibrium. No rationing occurs in equilibrium, but it does off the equilibrium path. Received: December 29, 1999; revised version: November 30, 2000     

Equilibrium selection in coordination games with simultaneous play

Summary. We apply the dynamic stochastic framework proposed in recent evolutionary literature to a class of coordination games played simultaneously by the entire population. In these games payoffs, and hence best replies, are determined by a summary statistic of the population strategy profile. We demonstrate that with simultaneous play, the equilibrium selection depends crucially on how best responses to the summary statistic remain piece-wise constant. In fact, all the strict Nash equilibria in the underlying stage game can be made stochastically stable depending on how the best response mapping generates piece-wise constant best responses. Received: February 12, 2001; revised version: October 29, 2001     

Signaling in markets with two-sided adverse selection

Summary. The paper analyzes an economy with two-sided adverse selection, focusing on equilibria that satisfy a refinement based on the notion of strategic stability. In the familiar case of one-sided adverse selection, agents reveal all of their private information as long as the contract space is rich enough. However, with two-sided adverse selection, the sufficient conditions for separation are much stronger. Received: September 3, 1999; revised version: December 3, 1999     

Equilibrium in a reinsurance market with short sale constraints

Summary. This paper deals with the existence of equilibrium in a dynamic reinsurance market with short sale constraints, driven by a marked point process, as studied in Bernis and Jouini (2001). We use the set of reinsurance treaties as consumption set, which is the positive orthant of some Banach lattice that can be identified to a space of martingales, . The properness of preferences is a key assumption for us to prove the existence of an equilibrium. We provide a sufficient condition for the preferences to be proper in term of loading factor of the reinsurance premium. Received: June 15, 2000; revised version: May 17, 2001     

Adverse selection under ignorance

Summary. We examine an adverse selection relationship in which the principal may ignore the ex ante distribution of the agent's types. The principal's behavior is described by a disutility function that covers the standard minimax regret and minimax loss criteria. We show that the incentive compatible and individually rational mechanism, which minimizes the maximal (or the minimal) principal's disutility over a set of priors, requires the efficient agents to realize the corresponding first-best actions and may demand actions lower than the first-best ones from less efficient agents. We also analyze the qualitative differences between the case in which the principal considers regrets and the case in which he considers losses. Received: 19 October 1998; revised version: 9 November 1999     

Liquidity supply and adverse selection in a pure limit order book market

This paper analyzes adverse selection costs and liquidity supply in a pure open limit order book market. We relax assumptions of the Glosten/Såndas modeling framework regarding marginal zero profit order book equilibrium and the parametric market order size distribution. We show that using average zero profit conditions considerably increases the empirical performance while a nonparametric specification for market order size combined with marginal zero profit conditions does not. A cross sectional analysis corroborates the finding that adverse selection costs are more severe for smaller capitalized stocks. We also find additional support for one of the central hypothesis put forth by the theory of limit order book markets, which states that liquidity supply and adverse selection costs are inversely related. Furthermore, adverse selection cost estimates based on our structural model and those obtained using popular model-free methods are strongly correlated. This indicates the robustness of the theory-based approach.     

Real-time decentralized information processing and returns to scale

We use a model of real-time decentralized information processing to understand how constraints on human information processing affect the returns to scale of organizations. We identify three informational (dis)economies of scale: diversification of heterogeneous risks (positive), sharing of information and of costs (positive), and crowding out of recent information due to information processing delay (negative). Because decision rules are endogenous, delay does not inexorably lead to decreasing returns to scale. However, returns are more likely to be decreasing when computation constraints, rather than sampling costs, limit the information upon which decisions are conditioned. The results illustrate how information processing constraints together with the requirement of informational integration cause a breakdown of the replication arguments that have been used to establish nondecreasing technological returns to scale. November 24, 1999; revised version: March 14, 2000     

Insurance contracts with imprecise probabilities and adverse selection

Summary. This article deals with optimal insurance contracts in the framework of imprecise probabilities and adverse selection. Agents differ not only in the objective risk they face but also in the perception of risk. In monopoly, a range of configurations that VNM preferences preclude appears: a pooling contract may be optimal, incomplete coverage may be offered to high risks, low risks may be better covered.Received: 1 November 2001, Revised: 15 April 2003, JEL Classification Numbers: D81, D82, G22.Useful suggestions by Emmanuelle Auriol, Bernard Bensaïd, Michéle Cohen, Isaac Meilijson and the anonymous referee are acknowledged. Correspondence to: M. Jeleva     

Equilibrium prices in a random exchange economy with dependent agents

Summary. This paper presents a model of a Walrasian exchange economy in which the preferences and endowments of the agents are random. Stochastic interaction among the agents is formally described in terms of dependency neighborhoods. The main result is a characterization of the distribution of market-clearing prices in a large economy. Received: April 23, 1999; revised version: May 6, 1999     

A general model of insurance under adverse selection

Summary. This paper considers optimal insurance schemes in a principal-agent multi-dimensional environment in which two types of risk averse agents differ in both risk and attitude to risk. Risk corresponds to any pair of distribution functions (not necessarily ordered by any of the usual dominance relations) and attitudes to risk are represented by any pair of non-decreasing and concave utility functions (not necessarily ordered by risk aversion). Results obtained in one-dimensional models that considered these effects separately and under more restricted conditions, are preserved in the more general set-up, but some of the questions we study can only be posed in the more general framework. The main results obtained for optimal insurance schemes are: (i) Insurance schemes preserve the order of certainty equivalents; consequently, the latter constitute a one-dimensional representation of types. (ii) Agents with the lower certainty equivalent are assigned full insurance. Partial insurance assigned to the others may entail randomization. (iii) Partially insured positions are an increasing function of the ratios of the probabilities that the two types assign to the uninsured positions. Most of these properties are preserved when, due to competition or other reasons, the insured certainty equivalents can not be set below pre-determined levels. Received: January 13, 1998; revised version: October 10, 1998     

Cycles and multiple equilibria in the market for durable lemons

Summary. The paper investigates the nature of market failure in a dynamic version of Akerlof (1970) where identical cohorts of a durable good enter the market over time. In the dynamic model, equilibria with qualitatively different properties emerge. Typically, in equilibria of the dynamic model, sellers with higher quality wait in order to sell and wait more than sellers of lower quality. The main result is that for any distribution of quality there exist an infinite number of cyclical equilibria where all goods are traded within a certain number of periods after entering the market. Received: December 21, 2000; revised version: September 5, 2001     

General equilibrium in economies with adverse selection

We model economies of adverse selection as Arrow–Debreu economies. In the spirit of Prescott and Townsend (Econometrica 52(1), 21–45, 1984a), we identify the consumption set of the individuals with the set of lotteries over net transfers. Thus, prices are linear in lotteries, but they may be non linear in commodity bundles. First, we study a weak equilibrium notion by viewing the economy of adverse selection as a pure exchange economy. The weak equilibrium set is non empty, but some of the allocations may be inefficient, and the equilibria indeterminate. Second, following Prescott and Townsend (Econometrica 52(1), 21–45, 1984a), we introduce an intermediary (firm) supplying feasible and incentive compatible measures. Equilibria are constrained efficient, but the equilibrium set is empty for an open set of economies containing the Rothschild and Stiglitz insurance economies. The research of A. Rustichini was supported by the NSF grant NSF/SES-0136556.     

Competitive search markets for durable goods

Summary. This paper considers a dynamic version of Akerlof's (1970) lemons problem where buyers and sellers must engage in search to find a trading partner. We show that if goods are durable, the market itself may provide a natural sorting mechanism. In equilibrium, high-quality goods sell at a higher price than low-quality goods but also circulate longer. This accords with the common wisdom that sellers who want to sell fast may have to accept a lower price. We then compare the equilibrium outcomes under private information with those under complete information. Surprisingly, we find that for a large range of parameter values the quilibrium outcomes under the two information regimes coincide, despite the fact that circulation time is used to achieve separation. Received: August 24, 2000; revised version: October 24, 2000     

Collusion and group lending with adverse selection

In an environment with correlated returns, this paper characterizes optimal lending contracts when the bank faces adverse selection and borrowers have limited liability. Group lending contracts are shown to be dominated by revelation mechanisms which do not use the ex post observability of the partners' performances. However, when collusion between borrowers under complete information is allowed, group lending contracts are optimal in the class of simple revelation mechanisms (which elicit only the borrower's own private information) and remain useful with extended revelation mechanisms.     

Strategic transmission of information and short-term commitment

Summary. We examine the strategic role of information transmission in a repeated principal-agent relationship where the agent produces information that is useful to the principal. The agent values continuous employment for the principal because he makes a relationship-specific investment that can yield rents to him when the relationship is renewed. Assuming that the parties are sufficiently impatient, we show that full disclosure of the information produced occurs early in the relationship when the principal can commit to a long-term relationship, when the agent observes his valuation of continuous employment after making a report on information produced, or when the agent obtains a low valuation of continuous employment before making a report. By contrast, a strategic delay in the transmission of information occurs when the principal can only commit to a short-term relationship and the agent obtains a high valuation of continuous employment before making a report. Received: October 15, 1997; revised version: July 27, 1998     

Endogenous market segmentation with heterogeneous agents

Summary. An explanation is provided for the evolution of segmented marketplaces in a pairwise exchange economy. Large traders operating in a pairwise exchange market prefer to meet other similar traders, because this enables them to trade their endowments in a smaller number of encounters. Large and small traders, however, cannot be distinguished a priori, and the existence of the small traders imposes a negative externality on the large traders. We show that, under conditions which are not very restrictive, establishing a separate market (perhaps with an entry fee) designated for the large traders induces the two types of traders to segment themselves. However, this segmentation is not necessarily welfare improving. Received: January 12, 2001; revised version: July 17, 2002 RID="*" ID="*" I wish to thank the participants in the Friday Theory Workshop at the University of Sydney, and the participants at the 17th Australian Theory Workshop at the University of Melbourne for comments and discussion. John Hillas and Stephen King pointed out an omission in an earlier version, and Catherine de Fontenay and Hodaka Morita made extensive comments on earlier drafts. This work was initiated while I was a short-term visitor at the University of Southern California.     

Real and financial effects of insider trading with correlated signals

Summary. In this paper we study the real and financial effects of insider trading in a Static, Kyle-type model. In our model the insider is also the manager of the firm. Hence the insider chooses both the amount of the real output to be produced and the amount of the stock of the firm to trade. The aim of the paper is to study the relationship between financial decisions and real decisions. In particular, we examine how insider trading on the stock market affects the real output and price and how the real decision making affects the financial variables, such as the extent of insider trading, stock prices, and the stock pricing rule of the market maker. In the model, the market maker observes two correlated signals: the total order flow and the market price of the real good. We study the informativeness of the stock price and the effects on insider's profits. We also construct a compensation scheme that aligns the interests of the insider and the firm. Finally, we generalize the pricing rule set up by a competitive market maker and analyze the comparative statics of the model. Received: October 3, 1999: revised version: December 1, 1999     

Equilibrium binding agreements under diverse behavioral assumptions

Summary. This paper extends the work of Ray and Vohra [3]. It ascertains which partitions of players will emerge and what actions will these players choose under each partition, when they can sign binding agreements and their actions have externalities. The emphasis, however, is placed on situations with multiple outcomes and how agents behave in the presence of such multiplicity. In particular, a deviating coalition considers all the likely outcomes that may prevail upon its deviation, and selects (if possible) a subset of them. Three augmentations of Ray and Vohra's [3] solution concept are defined, capturing three distinct behavioral assumptions. Efficiency of and the relation between the three notions are discussed. Received: October 9, 2001; revised version: April 22, 2002 RID="*" ID="*" I wish to thank Licun Xue, Joseph Greenberg and the participants of PET 2000 for very helpful suggestions. I am indebted to an anonymous referee for his/her valuable comments. The paper has been previously circulated under the title Binding Agreements.     

A strategic market game with seigniorage costs of Fiat money

Summary. A model that includes the cost of producing money is presented and the nature of the inefficient equilibria in the model are examined. It is suggested that if one acknowledges that transactions are a form of production, which requires the consumption of resources, then the concept of Pareto optimality is inappropriate for assessing efficiency. Instead it becomes necessary to provide an appropriate comparative analysis of alternative transactions mechanisms in the appropriate context. Received: September 5, 2000; revised version: May 3, 2001     

The core in an oligopoly market with indivisibility

Summary. This paper studies the core in an oligopoly market with indivisibility. It provides necessary and sufficient conditions for core existence in a general m-buyer n-seller market with indivisibility. When costs are dominated by opportunity costs (i.e., a firm's variable costs are sufficiently small), the core condition can be characterized by the primitive market parameters. In a 3-2 market with opportunity cost, the core is non-empty if and only if the larger seller's opportunity cost is either sufficiently large or sufficiently small. Received: June 9, 1999; revised version: October 22, 1999