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Ambiguity, optimism, and pessimism in adverse selection models

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  • Giraud, Raphaël
  • Thomas, Lionel

Abstract

We investigate the effect of ambiguity and ambiguity attitude on the shape and properties of the optimal contract in an adverse selection model with a continuum of types, using the NEO-additive model. We show that it necessarily features efficiency and a jump at the top and pooling at the bottom of the distribution. Conditional on the degree of ambiguity, the pooling section may be supplemented by a separating section. As a result, ambiguity adversely affects the principal's ability to solve the adverse selection problem and therefore the least efficient types benefit from ambiguity with respect to risk. Conversely, ambiguity is detrimental to the most efficient types.

Suggested Citation

  • Giraud, Raphaël & Thomas, Lionel, 2017. "Ambiguity, optimism, and pessimism in adverse selection models," Journal of Economic Theory, Elsevier, vol. 171(C), pages 64-100.
    • Handle: RePEc:eee:jetheo:v:171:y:2017:i:c:p:64-100
    DOI: 10.1016/j.jet.2017.06.004
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    Cited by:

    1. Li, Wenhui & Wilde, Christian, 2020. "Belief formation and belief updating under ambiguity: Evidence from experiments," SAFE Working Paper Series 251, Leibniz Institute for Financial Research SAFE, revised 2020.
    2. Daiki Kishishita & Susumu Sato, 2021. "Optimal risk regulation of monopolists with subjective risk assessment," Journal of Regulatory Economics, Springer, vol. 59(3), pages 251-279, June.
    3. Joaquín Gómez Miñambres & Mark Schneider, 2019. "Carrots and Sticks: Optimal Contracting with Skewness Preference and Ambiguity Aversion," Working Papers 19-02, Chapman University, Economic Science Institute.
    4. Gao, Yongling & Driouchi, Tarik & Bennett, David J., 2018. "Ambiguity aversion in buyer-seller relationships: A contingent-claims and social network explanation," International Journal of Production Economics, Elsevier, vol. 200(C), pages 50-67.
    5. Zheng, Shiyuan & Wang, Kun & Chan, Felix T.S. & Fu, Xiaowen & Li, Zhi-Chun, 2022. "Subsidy on transport adaptation investment-modeling decisions under incomplete information and ambiguity," Transportation Research Part B: Methodological, Elsevier, vol. 162(C), pages 103-129.

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    More about this item

    Keywords

    Adverse selection; Ambiguity; Ambiguity aversion; NEO-additive model; Non-expected utility models; Behavioral economics;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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