IDEAS home Printed from
   My bibliography  Save this article

Investment incentives in bilateral trading


  • Lau, Stephanie


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.

Suggested Citation

  • Lau, Stephanie, 2011. "Investment incentives in bilateral trading," Games and Economic Behavior, Elsevier, vol. 73(2), pages 538-552.
  • Handle: RePEc:eee:gamebe:v:73:y:2011:i:2:p:538-552
    DOI: 10.1016/j.geb.2011.02.006

    Download full text from publisher

    File URL:
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    1. Farrell, Joseph & Gibbons, Robert, 1995. "Cheap Talk about Specific Investments," Journal of Law, Economics, and Organization, Oxford University Press, vol. 11(2), pages 313-334, October.
    2. Schmitz, Patrick W., 2002. "On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems," Journal of Economic Theory, Elsevier, vol. 103(2), pages 444-460, April.
    3. Gul, Faruk, 2001. "Unobservable Investment and the Hold-Up Problem," Econometrica, Econometric Society, vol. 69(2), pages 343-376, March.
    4. Yilankaya, Okan, 1999. "A Note on the Seller's Optimal Mechanism in Bilateral Trade with Two-Sided Incomplete Information," Journal of Economic Theory, Elsevier, vol. 87(1), pages 267-271, July.
    5. Nicola Persico, 2000. "Information Acquisition in Auctions," Econometrica, Econometric Society, vol. 68(1), pages 135-148, January.
    6. William P. Rogerson, 1992. "Contractual Solutions to the Hold-Up Problem," Review of Economic Studies, Oxford University Press, vol. 59(4), pages 777-793.
    7. Ronald J. Gilson & Alan Schwartz, 2005. "Understanding MACs: Moral Hazard in Acquisitions," Journal of Law, Economics, and Organization, Oxford University Press, vol. 21(2), pages 330-358, October.
    8. Tirole, Jean, 1986. "Procurement and Renegotiation," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 235-259, April.
    9. William Vickrey, 1961. "Counterspeculation, Auctions, And Competitive Sealed Tenders," Journal of Finance, American Finance Association, vol. 16(1), pages 8-37, March.
    10. Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January.
    11. Myerson, Roger B. & Satterthwaite, Mark A., 1983. "Efficient mechanisms for bilateral trading," Journal of Economic Theory, Elsevier, vol. 29(2), pages 265-281, April.
    12. Leandro Arozamena & Estelle Cantillon, 2004. "Investment Incentives in Procurement Auctions," Review of Economic Studies, Oxford University Press, vol. 71(1), pages 1-18.
    13. Dino Gerardi & Leeat Yariv, 2008. "Costly Expertise," American Economic Review, American Economic Association, vol. 98(2), pages 187-193, May.
    14. Stephanie Lau, 2008. "Information and bargaining in the hold-up problem," RAND Journal of Economics, RAND Corporation, vol. 39(1), pages 266-282.
    15. d'Aspremont, Claude & Gerard-Varet, Louis-Andre, 1979. "Incentives and incomplete information," Journal of Public Economics, Elsevier, vol. 11(1), pages 25-45, February.
    16. Myerson, Roger B., 1982. "Optimal coordination mechanisms in generalized principal-agent problems," Journal of Mathematical Economics, Elsevier, vol. 10(1), pages 67-81, June.
    17. Schmitz, Patrick W., 2002. "On simple contracts, renegotiation under asymmetric information, and the hold-up problem," MPRA Paper 12530, University Library of Munich, Germany.
    18. Groves, Theodore, 1973. "Incentives in Teams," Econometrica, Econometric Society, vol. 41(4), pages 617-631, July.
    19. Schmitz, Patrick W., 2002. "Simple contracts, renegotiation under asymmetric information, and the hold-up problem," European Economic Review, Elsevier, vol. 46(1), pages 169-188, January.
    Full references (including those not matched with items on IDEAS)

    More about this item


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

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:gamebe:v:73:y:2011:i:2:p:538-552. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.