Discussion Paper No. 409
July 5, 2023
(Dis)honesty and the Value of Transparency for Campaign Promises
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Abstract:
Promise competition is prevalent in many economic environments, but promise keeping is often difficult to observe. We study the value of transparency for promise competition and ask whether promises still offer an opportunity to honor future obligations when outcomes do not allow for observing promise keeping. Focusing on campaign promises, we show theoretically how preferences for truth-telling shape promise competition when promise keeping can(not) be observed and identify the causal effects of transparency in an incentivized experiment. Transparency leads to less promise breaking but also to less generous promises. Rent appropriations are higher in opaque institutions though only weakly so when not fully opaque. Instrumental reputational concerns and preferences for truth-telling explain these results.
Keywords:
campaign promises; promise breaking; voting; lying costs; preferences for truth-telling; political Economy; theory; experiment;
JEL-Classification:
C91; C92; D72; D73; D91;
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Discussion Paper No. 391
March 29, 2023
On the (Ir)Relevance of Fee Structures in Certification
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Abstract:
Restrictions on certifiers’ fee structures are irrelevant for maximizing their profits and trade efficiency, and for the implementability of (monotone) distributions of rents. The irrelevance results exploit that certification schemes involve two substitutable dimensions—the fee structure and the disclosure rule—and adaptations in the disclosure dimension can mitigate restrictions on the fee dimension. While restrictions on fee structures do affect market transparency, it has no impact on economic efficiency or rent distributions.
Keywords:
certification; fee structures; disclosure rules; transparency;
JEL-Classification:
D82;
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Discussion Paper No. 368
January 20, 2023
Optimal Trade Execution under Endogenous Order Flow
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Abstract:
We consider an optimal liquidation model in which an investor is required to execute meta-orders during intraday trading periods, and his trading activity triggers child orders and endogenously affects future order flow, both instantaneously and permanently. Under the assumptions of risk neutrality and deterministic constants of the impact parameters, we provide closed-form solutions and illustrate the relationship between trading strategies and feedback effects. The optimal trading strategy is of hyperbolic form if the feedback effect of current trading on future order flow is not too strong. If the feedback effect becomes too dominating, a cyclic strategy with possible beneficial round-trips may emerge. We set up an estimation framework so that parameter estimates can be made directly from public data and are consistent with the theoretical model. When implementing our model on 110 NASDAQ stocks, the empirical analysis shows that as the level of endogeneity increases, our strategy provides increasingly better performance than the commonly adopted trading strategy. The empirical analysis also shows that too strong feedback effects do not exist in practice, thus ruling out statistical arbitrage.
Keywords:
liquidity risk; optimal trading strategy; portfolio liquidation; Hawkes process;
JEL-Classification:
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Discussion Paper No. 365
January 4, 2023
Biased Beliefs in Search Markets
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Abstract:
We study the implications of biased consumer beliefs for search market outcomes in the seminal framework due to Diamond (1971). Biased consumers base their search strategy on a belief function which specifies for any (true) distribution of utility offers in the market a possibly incorrect distribution of utility offers. If biased consumers overestimate the best offer in the market, a novel type of equilibrium may emerge in which firms make exceptionally favourable offers in order to meet biased consumers' unreasonable high expectations which then become partially self-fulfilling. Consequently, the presence of biased consumers may improve the welfare of all consumers.
Keywords:
consumer search; bounded rationality; cursed beliefs;
JEL-Classification:
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Discussion Paper No. 364
Competition in Search Markets with Naive Consumers
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Abstract:
We study the interplay between quality provision and consumer search in a search market where firms may design products of inferior quality to promote them to naive consumers who fail to fully understand product characteristics. We derive an equilibrium in which both superior and inferior quality is offered and show that as search frictions vanish, the share of firms offering superior goods in the market goes to zero. The presence of inferior products harms sophisticated consumers, as it forces them to search longer to find a superior product. We argue that policy interventions that reduce search frictions such as the standardization of price and package formats may harm welfare. In contrast, reducing the number of naive consumers through transparency policies and education campaigns as well as a minimum quality standard can improve welfare.
Keywords:
inferior products; competition; naivete; consumer search;
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Discussion Paper No. 362
Approximate Bayesian Implementation and Exact Maxmin Implementation: An Equivalence
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Abstract:
This paper provides a micro-foundation for approximate incentive compatibility using ambiguity aversion. In particular, we propose a novel notion of approximate interim incentive compatibility, approximate local incentive compatibility, and establish an equivalence between approximate local incentive compatibility in a Bayesian environment and exact interim incentive compatibility in the presence of a small degree of ambiguity. We then apply our result to the implementation of efficient allocations. In particular, we identify three economic settings—including ones in which approximately efficient allocations are implementable, ones in which agents are informationally small, and large double auctions—in which efficient allocations are approximately locally implementable when agents are Bayesian. Applying our result to those settings, we conclude that efficient allocations are exactly implementable when agents perceive a small degree of ambiguity.
Keywords:
approximate local incentive compatibility; ambiguity aversion; efficiency; informational size; modified VCG mechanism; double auction;
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Discussion Paper No. 361
Intertemporal Hedging and Trade in Repeated Games with Recursive Utility
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Abstract:
Recursive preferences have found widespread application in representative-agent asset-pricing models and general equilibrium. A majority of these applications exploit two decision-theoretic properties not shared by the standard model of intertemporal choice: (i) agents care about the intertemporal distribution of risk and (ii) rates of time preference, rather than being exogenously fixed, may vary with the level of consumption. We investigate what these features imply in the context of a repeated strategic interaction. Specifically, we identify novel opportunities for the players to manage risk and trade intertemporally, and characterize when such opportunities lead to an expansion of the fea- sible set of payoffs. Sharp implications for equilibrium behavior and the folk theorem are also deduced.
Keywords:
recursive utility; repeated games; correlation aversion; endogenous discounting; intertemporal trade; intertemporal hedging;
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Discussion Paper No. 356
Aggregate Information and Organizational Structures
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Abstract:
We study information flows in an organization with a top management (principal) and multiple subunits (agents) with private information that determines the organization's aggregate efficiency. Under centralization, eliciting the agents' private information may induce the principal to manipulate aggregate information, which obstructs an effective use of information for the organization. Under delegation, the principal concedes more information rent, but is able to use the agents' information more effectively. The trade-off between the organizational structures depends on the likelihood that the agents are efficient. Centralizing information flows is optimal when such likelihood is low. Delegation, by contrast, is optimal when it is high.
Keywords:
agency; aggregate information; organization design;
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Discussion Paper No. 348
November 30, 2022
Dynamic Screening with Verifiable Bankruptcy
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Abstract:
We consider a dynamic screening model where the agent may go bankrupt due to, for example, cash constraints. We model bankruptcy as a verifiable event that occurs whenever the agent makes a per period loss. This leads to less stringent truth-telling constraints than those considered in the existing literature. We show that the weaker constraints do not af- fect optimal contracting in private values settings but may do so with interdependent values. Moreover, we develop a novel method to study private values settings with continuous types and identify a new regularity condition that ensures that the optimal contract is deterministic.
Keywords:
dynamic screening; bankruptcy; verifiability; mean preserving spread;
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Discussion Paper No. 347
Correlation-Savvy Sellers
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Abstract:
A multi-product monopolist sells sequentially to a buyer who privately learns his valuations. Using big data, the monopolist learns the intertemporal correlation of the buyer's valuations. Perfect price discrimination is generally unattainable—even when the seller learns the correlation perfectly, has full commitment, and in the limit where the consumption good about which the buyer has ex ante private information becomes insignificant. This impossibility is due to informational externalities which requires information rents for the buyer's later consumption. These rents induce upward and downward distortions, violating the generalized no distortion at the top principle of dynamic mechanism design.
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