Endogenous Liquidity Constraints in a Dynamic Contest

Abstract

In this article, I analyze the effects of future liquidity constraints on the investment behavior of two contestants with asymmetric prize valuations in a dynamic contest model. Contestants compete in two consecutive Tullock contests in order to win a contest prize in each period. The loser of the first-period contest can be liquidity constraint in the second period. The model reveils the following four main results: (i) Future liquidity constraints marginally affect today's intensity of competition but rather influence tomorrow's contest. (ii) A higher contest prize in both periods surprisingly decreases aggregate second-period investment in a symmetric contest. (iii) Counterintuitively, a higher asymmetry with respect to the contest prize valuations increases the first-period investment of both contestants.(iv) The effect of a higher asymmetry on second-period investment depends on which contestant won the first-period contest. Further results are derived with respect to the existence and uniqueness of the equilibrium, competitive balance and expected total profits.