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Optimal Rating Design

Maryam Saeedi and Ali Shourideh

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Abstract: We study the design of optimal rating systems in the presence of adverse selection and moral hazard. Buyers and sellers interact in a competitive market where goods are vertically differentiated according to their qualities. Sellers differ in their cost of quality provision, which is private information to them. An intermediary observes sellers' quality and chooses a rating system, i.e., a signal of quality for buyers, in order to incentivize sellers to produce high-quality goods. We provide a full characterization of the set of payoffs and qualities that can arise in equilibrium under an arbitrary rating system. We use this characterization to analyze Pareto optimal rating systems when seller's quality choice is deterministic and random.

Date: 2020-08, Revised 2020-09
New Economics Papers: this item is included in nep-des and nep-mic
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