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Investment incentives in bilateral trading

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  • Lau, Stephanie
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    Abstract

    We characterize the surplus-maximizing trading mechanism under two-sided incomplete information and interim individual rationality, when one party can make a value-enhancing specific investment. This mechanism exhibits a trade-off between providing investment incentives and inducing voluntary participation. We analyze how the trading area of the optimal mechanism is further distorted in order to provide investment incentives. Applications of our main results and the underlying geometric analysis to institutional design issues are also provided.

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    Bibliographic Info

    Article provided by Elsevier in its journal Games and Economic Behavior.

    Volume (Year): 73 (2011)
    Issue (Month): 2 ()
    Pages: 538-552

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    Handle: RePEc:eee:gamebe:v:73:y:2011:i:2:p:538-552

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    Web page: http://www.elsevier.com/locate/inca/622836

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    Keywords: Bilateral trading; k-Double auctions; Incomplete contracts; Investment incentives; Optimal mechanism; Opt-out clause;

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    1. Dino Gerardi & Leeat Yariv, 2008. "Costly Expertise," American Economic Review, American Economic Association, vol. 98(2), pages 187-93, May.
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