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Unraveling in Assignment Markets

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Author Info
Hao Li
Shewin Rosen

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Abstract

We present a two-period model of the assignment market with uncertainty in the first period regarding productive characteristics of participants. This model is used to understand incentives toward early contracts or unraveling in labor markets for entry-level professionals. We study two contractual situations, one where firms are bound by ex post unsuccessful early contracts, and the other where they can buy out of unsuccessful early contracts. The economic benefit of unraveling is to provide insurance in the absence of complete markets, but it can come at the cost of inefficient assignments. Without reentry, unraveling need not occur. It is more likely, the smaller the applicant pool or the proportion of more promising applicants in the pool, and the greater the degree of heterogeneity in the pool. A ban on early contracts always hurts firms and benefits less promising applicants, but the welfare effects on more promising applicants depends on how the gains from early contracts are shared. With buyouts, inefficiencies in assignments are eliminated, and unraveling always occurs between firms and the more promising applicants. The efficiency gains of buyouts can be distributed unevenly and sometimes firms benefit from a ban on buyouts.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5729.

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Date of creation: Aug 1996
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Publication status: published as American Economic Review, Vol. 88 (June 1998): 371-387.
Handle: RePEc:nbr:nberwo:5729

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  1. Roth, Alvin E, 1991. "A Natural Experiment in the Organization of Entry-Level Labor Markets: Regional Markets for New Physicians and Surgeons in the United Kingdom," American Economic Review, American Economic Association, vol. 81(3), pages 415-40, June. [Downloadable!] (restricted)
  2. Tjalling C. Koopmans & Martin J. Beckmann, 1955. "Assignment Problems and the Location of Economic Activities," Cowles Foundation Discussion Papers 4, Cowles Foundation, Yale University. [Downloadable!]
  3. Roth, Alvin E. & Sotomayor, Marilda, 1992. "Two-sided matching," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 1, chapter 16, pages 485-541 Elsevier. [Downloadable!] (restricted)
  4. Crawford, Vincent P., 1991. "Comparative statics in matching markets," Journal of Economic Theory, Elsevier, vol. 54(2), pages 389-400, August. [Downloadable!] (restricted)
  5. Roth, Alvin E & Xing, Xiaolin, 1994. "Jumping the Gun: Imperfections and Institutions Related to the Timing of Market Transactions," American Economic Review, American Economic Association, vol. 84(4), pages 992-1044, September. [Downloadable!] (restricted)
  6. Roth, Alvin E, 1984. "The Evolution of the Labor Market for Medical Interns and Residents: A Case Study in Game Theory," Journal of Political Economy, University of Chicago Press, vol. 92(6), pages 991-1016, December. [Downloadable!] (restricted)
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