Business Intelligence

Adverse Selection In Competitive Search Equilibrium

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Executive Summary

The authors extend the concept of competitive search equilibrium to environments with private information, and in particular adverse selection. Principals (e.g. employers or agents who want to buy assets) post contracts, which they model as revelation mechanisms. Agents (e.g. workers or asset holders) have private information about the potential gains from trade. Agents observe the posted contracts and decide where to apply, trading off the contracts' terms of trade against the probability of matching, which depend in general on the principals' capacity constraints and market search frictions. They characterize equilibrium as the solution to a constrained optimization problem, and prove that principals offer separating contracts to attract different types of agents.

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