Bilateral trade with loss-averse agents

Jean-Michel Benkert

No 188, ECON - Working Papers from Department of Economics - University of Zurich

Abstract: The endowment and attachment effect are empirically well-documented in bilateral trade situations. Yet, the theoretical literature has so far failed to formally identify these effects. We fill this gap by introducing expectations-based loss aversion, which can explain both effects, into the classical setting by Myerson and Satterthwaite (1983). This allows us to formally identify the endowment and attachment effect and study their impact on information rents, allowing us to show that, in contrast to other behavioral approaches to the bilateral trade problem, the impossibility of inducing materially efficient trade persists in the presence of loss aversion. We then turn to the design of optimal mechanisms and consider the problem of maximizing the designer's revenue as well as gains from trade. We find that the designer optimally provides the agents with full insurance in the money dimension and, depending on the distribution of types, optimally increases or decreases the trade frequency in the presence of loss aversion.

Keywords: Bilateral trade; loss-aversion; mechanism design; endowment and attachment effect (search for similar items in EconPapers)
JEL-codes: C78 D01 D02 D82 D84 D90 (search for similar items in EconPapers)
Date: 2015-03, Revised 2022-07
New Economics Papers: this item is included in nep-cta, nep-int and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Working Paper: Bilateral Trade with Loss-Averse Agents (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:zur:econwp:188

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