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Ambiguity, Optimism, and Pessimism in Adverse Selection Models

Raphaël Giraud () and Lionel Thomas ()

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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 parametric model of ambiguity and ambiguity aversion called the NEO-additive model (Chateauneuf, Eichberger, and Grant, 2007). 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 or may not 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. This is confirmed in the comparative statics section.

Keywords: Adverse selection; ambiguity; ambiguity aversion; NEO-additive model; non-expected utility models; behavioral economics. (search for similar items in EconPapers)
Date: 2015-09-14
New Economics Papers: this item is included in nep-mic and nep-upt
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Journal Article: Ambiguity, optimism, and pessimism in adverse selection models (2017) Downloads
Working Paper: Ambiguity, Optimism, and Pessimism in Adverse Selection Models (2017)
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