Risk aversion and equilibrium selection in a vertical contracting setting: an experiment

The theoretical literature on vertical relationships usually assumes that beliefs about secret contracts take specific forms. In a recent paper, Eguia et al. (Games Econ Behav 109:465-483,2018) propose a new selection criterion that does not impose any restriction on beliefs. In this article, we extend their criterion by generalizing it to risk-averse retailers, and we show that risk aversion modifies the size of the belief subsets that support each equilibrium. We conduct an experiment which revisits that of Eguia et al. (Games Econ Behav 109:465-483,2018). We design a new treatment effect on equilibrium selection depending on the retailers' risk sensitivity. Experimental results confirm the treatment effect: the more sensitivity there is towards risk, the more the equilibrium played is consistent with passive beliefs. In addition, extending Eguia et al.'s (Games Econ Behav 109:465-483,2018) criterion to risk-averse retailers improves its predictive power on the equilibria played, especially for a population of retailers with moderate to extreme risk aversion.