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Ambiguity, optimism, and pessimism in adverse selection models

Raphaël Giraud and Lionel Thomas

Journal of Economic Theory, 2017, vol. 171, issue C, 64-100

Abstract: We investigate the effect of ambiguity and ambiguity attitude on the shape and properties of the optimal contract in an adverse selection model with a continuum of types, using the NEO-additive model. We show that it necessarily features efficiency and a jump at the top and pooling at the bottom of the distribution. Conditional on the degree of ambiguity, the pooling section may be supplemented by a separating section. As a result, ambiguity adversely affects the principal's ability to solve the adverse selection problem and therefore the least efficient types benefit from ambiguity with respect to risk. Conversely, ambiguity is detrimental to the most efficient types.

Keywords: Adverse selection; Ambiguity; Ambiguity aversion; NEO-additive model; Non-expected utility models; Behavioral economics (search for similar items in EconPapers)
JEL-codes: D81 D82 (search for similar items in EconPapers)
Date: 2017
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Working Paper: Ambiguity, Optimism, and Pessimism in Adverse Selection Models (2015) Downloads
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