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Market signaling with grades

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  • Daley, Brendan
  • Green, Brett

Abstract

We consider a signaling model in which receivers observe both the sender's costly signal as well as a stochastic grade that is correlated with the sender's type. In equilibrium, the sender resolves the trade-off between using the costly signal versus relying on the noisy grade to distinguish himself. We derive a necessary and sufficient condition—loosely, that the grade is sufficiently informative relative to the dispersion of (marginal) signaling costs across types—under which the presence of grades substantively alters the equilibrium predictions. Specifically, separating equilibria do not survive stability-based refinements. Instead, the prediction depends on the prior distribution over the sender's type. For example, with two types it involves full pooling when the distribution places sufficient weight on the high type and partial pooling otherwise. Finally, the equilibrium converges to the complete-information outcome as the distribution tends to a degenerate one—resolving a long-standing paradox within the signaling literature.

Suggested Citation

  • Daley, Brendan & Green, Brett, 2014. "Market signaling with grades," Journal of Economic Theory, Elsevier, vol. 151(C), pages 114-145.
  • Handle: RePEc:eee:jetheo:v:151:y:2014:i:c:p:114-145
    DOI: 10.1016/j.jet.2013.10.009
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    References listed on IDEAS

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    Cited by:

    1. Beetsma, Roel & Debrun, Xavier & Sloof, Randolph, 2017. "The political economy of fiscal transparency and independent fiscal councils," CEPR Discussion Papers 12181, C.E.P.R. Discussion Papers.
    2. Dato, Simon & Grunewald, Andreas & Kräkel, Matthias & Müller, Daniel, 2016. "Asymmetric employer information, promotions, and the wage policy of firms," Games and Economic Behavior, Elsevier, vol. 100(C), pages 273-300.
    3. Sadowski, Philipp, 2016. "Overeagerness," Journal of Economic Behavior & Organization, Elsevier, vol. 131(PA), pages 114-125.
    4. Dilmé, Francesc, 2017. "Noisy signaling in discrete time," Journal of Mathematical Economics, Elsevier, vol. 68(C), pages 13-25.
    5. repec:eee:gamebe:v:110:y:2018:i:c:p:50-57 is not listed on IDEAS
    6. repec:eee:gamebe:v:104:y:2017:i:c:p:632-655 is not listed on IDEAS
    7. Gea M. Lee & Seung Han Yoo, 2013. "Unobserved Investment, Signaling, and Welfare," Discussion Paper Series 1301, Institute of Economic Research, Korea University, revised 2017.
    8. Francesc Dilmé & Fei Li, 2016. "Dynamic Signaling with Dropout Risk," American Economic Journal: Microeconomics, American Economic Association, vol. 8(1), pages 57-82, February.
    9. Helmut Bester & Prof Matthias Lang & Jianpei Li, 2018. "Signaling versus Auditing," CESifo Working Paper Series 7183, CESifo Group Munich.
    10. Philipp Denter & John Morgan & Dana (D.) Sisak, 2018. "Showing Off or Laying Low? The Economics of Psych-outs," Tinbergen Institute Discussion Papers 18-041/VII, Tinbergen Institute.
    11. repec:aea:aecrev:v:107:y:2017:i:6:p:1638-55 is not listed on IDEAS
    12. Bester, Helmut & Lang, Matthias & Li, Jianpei, 2018. "Signaling versus costly information acquisition," Discussion Papers 2018/11, Free University Berlin, School of Business & Economics.

    More about this item

    Keywords

    Signaling; Asymmetric information; Information economics;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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