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Bilateral trade with loss-averse agents


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.

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.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Department of Economics
Dewey Decimal Classification:330 Economics
JEL Classification:C78, D02, D03, D82, D84
Uncontrolled Keywords:Bilateral trade, loss-aversion, mechanism design
Language:English
Date:September 2016
Deposited On:17 Mar 2015 13:03
Last Modified:16 Aug 2017 07:58
Series Name:Working paper series / Department of Economics
Number of Pages:48
ISSN:1664-7041
Additional Information:Revised version
Official URL:http://www.econ.uzh.ch/static/wp/econwp188.pdf
Related URLs:http://www.econ.uzh.ch/static/workingpapers.php

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