Robust contracting under common value uncertainty

Sarah Auster ()
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Sarah Auster: Department of Decision Sciences and IGIER, Bocconi University

Theoretical Economics, 2018, vol. 13, issue 1

Abstract: A buyer makes an offer to a privately informed seller for a good of uncertain quality. Quality determines both the seller's valuation and the buyer's valuation and the buyer evaluates each contract according to its worst-case performance over a set of probability distributions. The paper demonstrates that the contract that maximizes the minimum payoff over all possible probability distributions of quality is a screening menu that separates all types, whereas the optimal contract for any given probability distribution is a posted price, which induces bunching. Using the ϵ-contamination model, according to which the buyer's utility is a weighted average of his single prior expected utility and the worst-case scenario, the analysis further shows that for intermediate degrees of confidence the optimal mechanism combines features of both of these contracts.

Keywords: Ambiguity aversion; optimal contracting; lemons problem (search for similar items in EconPapers)
JEL-codes: D81 D82 D86 (search for similar items in EconPapers)
Date: 2018-01-31
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Citations: View citations in EconPapers (14)

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