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Ambiguity, optimism, and pessimism in adverse selection models

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  • Giraud, Raphaël
  • Thomas, Lionel

Abstract

We investigate the effect of ambiguity and ambiguity attitude on the shape and properties of the optimal contract in an adverse selection model with a continuum of types, using the NEO-additive model. We show that it necessarily features efficiency and a jump at the top and pooling at the bottom of the distribution. Conditional on the degree of ambiguity, the pooling section may be supplemented by a separating section. As a result, ambiguity adversely affects the principal's ability to solve the adverse selection problem and therefore the least efficient types benefit from ambiguity with respect to risk. Conversely, ambiguity is detrimental to the most efficient types.

Suggested Citation

  • Giraud, Raphaël & Thomas, Lionel, 2017. "Ambiguity, optimism, and pessimism in adverse selection models," Journal of Economic Theory, Elsevier, vol. 171(C), pages 64-100.
  • Handle: RePEc:eee:jetheo:v:171:y:2017:i:c:p:64-100
    DOI: 10.1016/j.jet.2017.06.004
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    Keywords

    Adverse selection; Ambiguity; Ambiguity aversion; NEO-additive model; Non-expected utility models; Behavioral economics;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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