Bilateral Trade with Loss-Averse Agents

Abstract

We study the bilateral trade problem put forward by Myerson and Satterthwaite (1983) under the assumption that agents are loss-averse, using the model developed by Kőszegi and Rabin (2006, 2007). We show that the endowment effect increases the sellers information rent, and that the attachment effect reduces the buyer's information rent. Further, depending on the distribution of types, loss-aversion can reduce the severity of the impossibility problem. However, the result cannot be reversed. Turning to the design of optimal mechanisms, we show that in both revenue and welfare maximizing mechanisms the designer optimally provides the agents with full insurance in the money dimension and with partial insurance in the trade dimension. In fact, when the stakes are large, loss-aversion can eliminate trade altogether. We show that all results display robustness to the exact specification of the reference point and provide some results on general mechanism design problems.

Fair Wages and Effort Provision: Combining Evidence from a Choice Experiment and a Field Experiment

“…In a series of influential papers, Kőszegi and Rabin (2006, 2009 developed a model of reference-dependent preferences and loss aversion where "gain-loss utility" is derived from standard "consumption utility," and the reference point is determined endogenously by rational expectations. Their model has found many fruitful applications in different areas of economics, finance, and decision analysis, including firms' pricing and advertising strategies Kőszegi 2008, 2014;Spiegler 2012;Herweg and Mierendorff 2013;Peitz 2014, 2017;Rosato 2016;Karle and Schumacher 2017), incentives provision (Herweg et al 2010, Eliaz and Spiegler 2015, Daido and Murooka, 2016, Macera 2018, tournaments and contests (Gill and Stone 2010, Gül Mermer 2017, Dato et al 2018, Fu et al 2019, asset pricing (Pagel 2016), life cycle consumption (Pagel 2017), and bilateral negotiations (Benkert 2017, Rosato 2017, Herweg et al 2018. In particular, there have been several studies on the implications of expectations-based loss aversion Balzer and Rosato: Expectations-Based Loss Aversion in Auctions Management Science, Articles in Advance, pp.…”

Better Later Than Never? An Experiment on Bargaining Under Adverse Selection

“…A recent paper by Benkert () addresses the loss aversion problem in a mechanism design bilateral trade setup.…”

On the Equivalence of Optimal Mechanisms with Loss and Disappointment Aversion

“…in Bierbrauer and Netzer (2016), rather than the more classical approach in Bergemann and Morris (2005). Beyond this general insight, our result has some immediate applications.…”