Open AccessRobust contracting under common value uncertainty
Author(s) -
Auster Sarah
Publication year - 2018
Publication title -
theoretical economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.404
H-Index - 32
eISSN - 1555-7561
pISSN - 1933-6837
DOI - 10.3982/te2385
Subject(s) - valuation (finance) , stochastic game , probability distribution , expected utility hypothesis , quality (philosophy) , computer science , set (abstract data type) , microeconomics , econometrics , mathematical optimization , mathematical economics , economics , mathematics , statistics , philosophy , finance , epistemology , programming language
A buyer makes an offer to a privately informed seller for a good of uncertain quality. Quality determines both the seller's valuation and the buyer's valuation, and the buyer evaluates each contract according to its worst‐case performance over a set of probability distributions. This paper demonstrates that the contract that maximizes the minimum payoff over all possible probability distributions of quality is a screening menu that separates all types, whereas the optimal contract for any given probability distribution is a posted price, which induces bunching. Using the ε ‐contamination model, according to which the buyer's utility is a weighted average of his single prior expected utility and the worst‐case scenario, the analysis further shows that for intermediate degrees of confidence, the optimal mechanism combines features of both of these contracts.