Exit options in incomplete contracts with asymmetric information

Helmut Bester and Daniel Krähmer

Journal of Economic Theory, 2012, vol. 147, issue 5, 1947-1968

Abstract: This paper analyzes bilateral contracting in an environment with contractual incompleteness and asymmetric information. One party (the seller) makes an unverifiable quality choice and the other party (the buyer) has private information about its valuation. A simple deterministic exit option contract, which allows the buyer to refuse trade, achieves the first-best in the benchmark cases where either quality is verifiable or the buyerʼs valuation is public information. But, when unverifiable and asymmetric information are combined, deterministic contracts are necessarily inefficient. The first-best can be achieved, however, through simple message games with stochastic terms of trade as off-equilibrium outcomes.

Keywords: Incomplete contracts; Asymmetric information; Option contracts (search for similar items in EconPapers)
JEL-codes: D82 D86 L15 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:147:y:2012:i:5:p:1947-1968

DOI: 10.1016/j.jet.2012.05.008

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