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Decentralized Markets with Informational Asymmetries

Final Report Summary - INFOASYMMARKETS (Decentralized Markets with Informational Asymmetries)

The goal of InfoAsymMarkets is to advance the theory of decentralized markets with repeated trading and informational asymmetries. Repeated transactions are natural both when the objects of trade are non-durable (e.g. services such as phone or internet plans) and when they are durable but divisible (e.g. financial assets).

The paper "Bargaining over a divisible object in the market for lemons" studies decentralized trading in the presence of divisibility and informational asymmetries. Negotiations over divisible goods typically regard both the price at which the good is sold and the amount that will be traded. Divisibility opens new channels through which the parties can convey their private information.
In our model, a buyer and a seller bargain over multiple units of a certain good. The seller is informed about the quality of the good which affects both parties' valuations. The buyer makes an offer in every period and learns about the good's quality only through the seller's behavior. We characterize the limiting equilibrium outcome as bargaining frictions vanish and the good becomes arbitrarily divisible. When the gains from trade decrease in the number of units already traded, the gradual sale of high-quality goods arises as the main signaling device in the market. We also show that the limiting outcome is Coasean: the competition with his future selves drives the buyer's payoff to the lowest possible level.

In "Dynamic contracting with limited commitment and the ratchet effect" we study repeated trading of non-durable goods. A firm and a worker interact for potentially infinitely many periods. The worker is privately informed about his productivity and the firm can only commit to short-term contracts. The ratchet effect is in place since the firm has the incentive to change the terms of trade and offer more demanding contracts when it learns that the worker is highly productive.
In our benchmark model, the relationship between the parties ends when the worker rejects all the contracts offered by the firm. We show that as the parties become arbitrarily patient, the equilibrium outcome takes one of two forms. If the prior probability of the worker being productive is low, the firm offers a pooling contract and no information is ever revealed. In contrast, if this prior probability is high, the firm fires the unproductive worker at the very beginning of the relationship.
We analyze an extension of the model that allows for rehiring. We show that a version of the folk theorem holds. In particular, when the parties are sufficiently patient, the firm can obtain a payoff arbitrarily close to the payoff of the optimal mechanism with commitment.

We have also investigated the properties of the equilibrium outcomes in large decentralized markets with aggregate uncertainty and one-sided private information. In "Efficiency in Decentralized Markets with Aggregate Uncertainty" we analyze a market in which uninformed buyers and informed sellers are randomly and anonymously matched in pairs over time, and buyers make the offers. Gains from trade are positive in every state of the world. We show that all equilibria become efficient as trading frictions vanish.