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simultaneous search

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  • lones smith
  • hector chade

Abstract

We introduce and solve a new class of static portfolio choice problems, where only the best realized alternative matters. A decision maker must simultaneously choose among independent ranked options, and the better alternatives have a lower chance of panning out. Each choice is costly, and just one option may be exercised. This often emerges in practice: (i) A student must make a costly and simultaneous application to many colleges, and is accepted with smaller chances by the better schools. (ii) An economics department must decide which of several PhD job candidates to fly out, and the better recruits will be available with smaller probability. We show that this problem entails maximizing a submodular function of finite sets --- which is NP hard in general. Still, we develop a marginal improvement algorithm that produces the optimal set in a quadratic number of steps. Applying it, we then show that the optimal choices are less risky than the sequentially optimal ones in Weitzman (1979), but riskier than the best singleton college choices. We also give practical rules of thumb, such as: (i) don't insure, choosing a safety school; instead, take risks; (ii) apply to an upwardly diverse portfolio of schools

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 64.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:64

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Keywords: search; submodular function;

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References

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  1. James Albrecht & Pieter Gautier, 2004. "Equilibrium Directed Search with Multiple Applications," Econometric Society 2004 Latin American Meetings, Econometric Society 330, Econometric Society.
  2. Hector Chade & Lones Smith, . "Simultaneous Search," Working Papers, Department of Economics, W. P. Carey School of Business, Arizona State University 2168591, Department of Economics, W. P. Carey School of Business, Arizona State University.
  3. Kenneth Burdett & Shouyong Shi & Randall Wright, 2001. "Pricing and Matching with Frictions," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 109(5), pages 1060-1085, October.
  4. Hector Chade & Greg Lewis & Lones Smith, 2006. "The College Admissions Problem Under Uncertainty," 2006 Meeting Papers, Society for Economic Dynamics 125, Society for Economic Dynamics.
  5. Gul, Faruk & Stacchetti, Ennio, 1999. "Walrasian Equilibrium with Gross Substitutes," Journal of Economic Theory, Elsevier, Elsevier, vol. 87(1), pages 95-124, July.
  6. Milgrom, Paul & Shannon, Chris, 1994. "Monotone Comparative Statics," Econometrica, Econometric Society, Econometric Society, vol. 62(1), pages 157-80, January.
  7. Burdett, Kenneth & Judd, Kenneth L, 1983. "Equilibrium Price Dispersion," Econometrica, Econometric Society, Econometric Society, vol. 51(4), pages 955-69, July.
  8. M. L. Weitzman, 1978. "Optimal Search for the Best Alternative," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 214, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Goldengorin, Boris & Tijssen, Gert A. & Tso, Michael, 1999. "The maximization of submodular functions : old and new proofs for the correctness of the dichotomy algorithm," Research Report 99A17, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  10. George J. Stigler, 1961. "The Economics of Information," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 69, pages 213.
  11. Kelso, Alexander S, Jr & Crawford, Vincent P, 1982. "Job Matching, Coalition Formation, and Gross Substitutes," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1483-1504, November.
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