Benkert, Jean-Michel (2016). Bilateral trade with loss-averse agents. Working paper series / Department of Economics 188, University of Zurich.

Abstract

We study the bilateral trade problem put forward by Myerson and Satterthwaite (1983) under the assumption that agents are loss-averse, using the model developed by Kőszegi and Rabin (2006, 2007). We show that the endowment effect increases the sellers information rent, and that the attachment effect reduces the buyer’s information rent. Further, depending on the distribution of types, loss-aversion can reduce the severity of the impossibility problem. However, the result cannot be reversed. Turning to the design of optimal mechanisms, we show that in both revenue and welfare maximizing mechanisms the designer optimally provides the agents with full insurance in the money dimension and with partial insurance in the trade dimension. In fact, when the stakes are large, loss-aversion can eliminate trade altogether. We show that all results display robustness to the exact specification of the reference point and provide some results on general mechanism design problems.

We study the bilateral trade problem put forward by Myerson and Satterthwaite (1983) under the assumption that agents are loss-averse, using the model developed by Kőszegi and Rabin (2006, 2007). We show that the endowment effect increases the sellers information rent, and that the attachment effect reduces the buyer’s information rent. Further, depending on the distribution of types, loss-aversion can reduce the severity of the impossibility problem. However, the result cannot be reversed. Turning to the design of optimal mechanisms, we show that in both revenue and welfare maximizing mechanisms the designer optimally provides the agents with full insurance in the money dimension and with partial insurance in the trade dimension. In fact, when the stakes are large, loss-aversion can eliminate trade altogether. We show that all results display robustness to the exact specification of the reference point and provide some results on general mechanism design problems.

Detailed statistics

Item Type: Working Paper 03 Faculty of Economics > Department of Economics Working Paper Series > Department of Economics 330 Economics C78, D02, D03, D82, D84 Bilateral trade, loss-aversion, mechanism design English September 2016 17 Mar 2015 13:03 28 Sep 2016 13:00 Working paper series / Department of Economics 48 1664-7041 Revised version http://www.econ.uzh.ch/static/wp/econwp188.pdf http://www.econ.uzh.ch/static/workingpapers.php
Permanent URL: https://doi.org/10.5167/uzh-109940