B02
Optimal Dynamic Contracting
Discussion Papers

Discussion Paper No. 255
August 25, 2020

Common Information-processing Irrationality as Trade Creator

Author:

Klishchuk, Bogdan (HU Berlin)

Abstract:

We show that a common (identical across investors) irrationality in information processing can be enough to create nontrivial trade, using one of standard partial-equilibrium environments. We can attribute this trade to their common irrationality because we strip the investors and their circumstances of all heterogeneities but purely age (in a sense experience), make investment horizon age-independent, and keep all information complete. The common irrationality in our model takes the form of a somewhat non-Bayesian information processing. The resulting trade between such essentially identical individuals with the very same irrationality in their information processing can also feature different kinds of mispricing.

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Discussion Paper No. 251
July 23, 2020

Public Good Overprovision by a Manipulative Provider

Author:

Celik, Gorkem (ESSEC Business School)
Shin, Dongsoo (Santa Clara University)
Strausz, Roland (HU Berlin)

Abstract:

We study contracting between a public good provider and users with private valuations of the good. We show that, once the provider extracts the users' private information, she benefits from manipulating the collective information received from all users when communicating with them. We derive conditions under which such manipulation determines the direction of distortions in public good provision. If the provider is non-manipulative, the public good is always underprovided, whereas overprovision occurs with a manipulative provider. With overprovision, not only high-valuation users, but also low-valuation users may obtain positive rents - users may prefer facing a manipulative provider.

Keywords:

information manipulation; public goods

JEL-Classification:

D82; D86; H41

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Discussion Paper No. 242
May 14, 2020

Robust Contracting in General Contract Spaces

Author:

Backhoff-Veraguas, Julio (University of Twente)
Beissner, Patrick (Australian National University)
Horst, Ulrich (HU Berlin)

Abstract:

We consider a general framework of optimal mechanism design under adverse selection and ambiguity about the type distribution of agents. We prove the existence of optimal mechanisms under minimal assumptions on the contract space and prove that centralized contracting implemented via mechanisms is equivalent to delegated contracting implemented via a contract menu under these assumptions. Our abstract existence results are applied to a series of applications that include models of optimal risk sharing and of optimal portfolio delegation.

Keywords:

robust contracts; nonmetrizable contract spaces; ambiguity; financial markets

JEL-Classification:

C02; D82

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Discussion Paper No. 230
March 2, 2020

Repeated Games with Endogenous Discounting

Author:

Kochov, Asen (University of Rochester)
Song, Yangwei (HU Berlin)

Abstract:

In a symmetric repeated game with standard preferences, there are no gains from intertemporal trade. In fact, under a suitable normalization of utility, the payoff set in the repeated game is identical to that in the stage game. We show that this conclusion may no longer be true if preferences are recursive and stationary, but not time separable. If so, the players’ rates of time preference are no longer fixed, but may vary endogenously, depending on what transpires in the course of the game. This creates opportunities for intertemporal trade, giving rise to new and interesting dynamics. For example, the efficient and symmetric outcome of a repeated prisoner’s dilemma may be to take turns defecting, even though the efficient and symmetric outcome of the stage game is to cooperate. A folk theorem shows that such dynamics can be sustained in equilibrium if the players are sufficiently patient.

Keywords:

repeated games; efficiency; folk theorems; endogenous discounting

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Discussion Paper No. 228
January 20, 2020

Behavior-Based Price Discrimination under Endogenous Privacy

Author:

Heiny, Friederike (HU Berlin)
Li, Tianchi (HU Berlin)
Tolksdorf, Michel (TU Berlin)

Abstract:

This paper analyzes consumers’ privacy choice concerning their private data and firms’ ensuing pricing strategy. The General Data Protection Regulation passed by the European Union in May 2018 allows consumers to decide whether to reveal private information in the form of cookies to an online seller. By incorporating this endogenous decision into a duopoly model with behavior-based pricing, we find two contrasting equilibria. Under revelation to both firms, consumers disclose their information. Under revelation to only one firm, consumers hide their information. Based on the model, we design a laboratory experiment. We find that there is a large share of consumers who reveal their private data. Particularly, less privacy-concerned subjects and subjects in the setting where only one firm receives information are more likely to reveal information.

Keywords:

behavior-based pricing; privacy; laboratory experiment

JEL-Classification:

C91; D11; D43; L13

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Discussion Paper No. 208
December 5, 2019

School Choice and Loss Aversion

Author:

Meisner, Vincent (TU Berlin)
von Wangenheim, Jonas (FU Berlin)

Abstract:

Extensive evidence suggests that participants in the direct student-proposing deferred-acceptance mechanism (DSPDA) play dominated strategies. In particular, students with low priority tend to misrepresent their preferences for popular schools. To explain the observed data, we introduce expectationbased loss aversion into a school-choice setting and characterize choiceacclimating personal equilibria in DSPDA. Truthful equilibria can fail to exist, and DSPDA might implement unstable and more inefficient allocations in both small and large markets. Speci fically, it discriminates against students who are more loss averse or less overconfident than their peers, and amplifi es already existing (or perceived) discrimination. To level the playing field, we propose serial dictatorship mechanisms as a strategyproof and stable alternative that is robust to these biases.

Keywords:

market design; matching; school choice; reference-dependent preferences; loss aversion; deferred acceptance

JEL-Classification:

C78; D78; D82; D81; D91

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Discussion Paper No. 183
September 18, 2019

The More the Merrier? On the Optimality of Market Size Restrictions

Author:

Colin von Negenborn (HU Berlin)

Abstract:

This paper provides a novel rationale for the regulation of market size when heterogeneous firms compete. A regulator seeks to maximize total welfare by choosing the number of firms allowed to enter the market, e.g. by issuing a certain number of licenses. Opening up the market for more firms has a two-fold effect: it increases competition and thus welfare, but at the same time, it also attracts more cost-intensive firms, driving down average production efficiency. The regulator hence faces a trade-off between raising beneficial competition and detrimental costs. If goods are sufficiently substitutable, the latter effect can outweigh the former. It is then optimal to restrict the market size, rationalizing a limit to competition. This result holds even in the absence of entry costs, search costs or increasing returns to scale, which previous literature required.

Keywords:

regulation; imperfect competition; oligopolies

JEL-Classification:

D43; L13; L51

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Discussion Paper No. 175
August 5, 2019

Speculative Trade and Market Newcomers

Author:

Klishchuk, Bogdan (HU Berlin)

Abstract:

Arguing that in the real world relatively optimistic inexperienced investors are prey for relatively pessimistic veteran traders, we formalize this intuitive conjecture as a proven proposition in a simple model. This agreement to disagree leads to a perpetual bubble, in which more experienced, but less optimistic, investors keep selling overpriced assets to less experienced traders. As in a fraction of the uniform-experience literature, lack of short-selling makes room for the success of such bubble schemes. This previous literature did not allow for persistent effects of experience on beliefs and, instead, relied on more direct assumptions of belief heterogeneity. Although we map experience into beliefs in a specific way, the intuition behind the perpetual bubble involves the above-mentioned disagreement patterns, not belief formation itself.

Keywords:

speculative trade; price bubble; experience; optimism; belief heterogeneity; non-bayesian learning; short-selling

JEL-Classification:

D08; D09; G01; G04

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Discussion Paper No. 142
February 23, 2019

Equilibria Under Knightian Price Uncertainty

Authors:

Beissner, Patrick (ANU)
Riedel, Frank (IMW Bielefeld University)

Abstract:

We study economies in which agents face Knightian uncertainty about state prices. Knightian uncertainty leads naturally to nonlinear expectations. We introduce a corresponding equilibrium concept with sublinear prices and prove that equilibria exist under weak conditions. In general, such equilibria lead to Pareto inefficient allocations; the equilibria coincide with Arrow-Debreu equilibria only if the values of net trades are ambiguity-free in the mean. In economies without aggregate uncertainty, inefficiencies are generic. We introduce a constrained efficiency concept, uncertainty-neutral efficiency, equilibrium allocations under price uncertainty are efficient in this constrained sense. Arrow-Debreu equilibria turn out to be non-robust with respect to the introduction of Knightian uncertainty.

Keywords:

JEL-Classification:

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Discussion Paper No. 129
December 20, 2018

Mean-Field Leader-Follower Games with Terminal State Constraint

Authors:

Fu, Guanxing (HU Berlin)
Horst, Ulrich (HU Berlin)

Abstract:

We analyze linear McKean-Vlasov forward-backward SDEs arising in leader-follower games with mean-field type control and terminal state constraints on the state process. We establish an existence and uniqueness of solutions result for such systems in time-weighted spaces as well as a convergence result of the solutions with respect to certain perturbations of the drivers of both the forward and the backward component. The general results are used to solve a novel single-player model of portfolio liquidation under market impact with expectations feedback as well as a novel Stackelberg game of optimal portfolio liquidation with asymmetrically informed players.

Keywords:

mean-field control; stackelberg game; mean-field game with a major player; portfolio liquidation

JEL-Classification:

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