Research

This paper studies how security design affects project outcomes. Consider a firm that raises capital for multiple projects by offering investors a share of the revenues. The revenue of each project is determined ex-post through bargaining with a buyer of the output. Thus the choice of security affects the feasible payoffs of the bargaining game. We characterize the securities that achieve the firm's maximal equilibrium payoff in bilateral and multilateral negotiations. In a large class of securities, the optimal contract is remarkably simple. The firm finances each project separately with defaultable debt. Welfare and empirical implications are discussed. 

This paper characterizes the optimal information structure in competitive insurance markets with adverse selection. We consider a regulator that assigns ratings to individuals according to their expected costs. Insurers observe these ratings and compete as in Akerlof 1970. The optimal rating system minimizes ex-ante risk subject to participation constraints. We prove that in any such market there exists a unique optimal system under which all individuals trade and the ratings match low-cost types with high-cost types negative assortatively. We provide a simple algorithm that yields the optimal system and examine implications for government regulations of insurance markets.

Numerous studies and experiments suggest that aspirations for desired but perhaps unavailable alternatives influence decisions. A common finding is that an unavailable aspiration steers agents to choose similar available alternatives. We propose and axiomatically characterize a choice theory consistent with this aspirational effect. Similarity is modeled using a subjective metric derived from choice data. This model offers implications for consumer welfare and its distribution between rich and poor when firms compete for aspirational agents, and a novel rationale for sales.

When consumers are not fully cognizant of the value of a good, they use their experience to estimate its value. Their past experience is selective if it only contains transactions that were carried out but not potential transactions that were not implemented. Failing to account for this selectivity may result in biased estimates of the post-purchase value. This paper presents a bounded rationality model of this process and investigates consequences vis-à-vis the abnormal disparity between willingness to pay (WTP) and willingness to accept (WTA). Implications for experimental findings concerning the dependence of the WTA/WTP ratio on a good’s characteristics and the negative correlation between market experience and the endowment effect are discussed.