Working Paper: CEPR ID: DP5434
Authors: Kfir Eliaz; Rani Spiegler
Abstract: When agents hold non-common priors over an unverifiable state of nature which affects the outcome of their future actions, they have an incentive to bet on the outcome. We pose the following question: what are the limits on the agents' ability to realize gains from speculative bets when their prior belief is private information? We apply a 'mechanism design' approach to this question, in the context of a pair of models: a principal-agent model in which the two parties bet on the agent's future action, and a market model in which traders bet on the future price. We characterize interim-efficient bets in these environments, and their implementability as a function of fundamentals. In general, implementability of interim-efficient bets diminishes as the costs of manipulating the bet's outcome become more uneven across states or agents.
Keywords: mechanism design; noncommon priors; partnership dissolution; speculative trade
JEL Codes: D82; D84; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Costs of manipulation (D23) | Implementability of interim-efficient bets (D81) |
| Asymmetric information (D82) | Potential for speculative trade (G13) |
| Uneven costs of manipulation (D43) | Implementability of interim-efficient bets (D81) |
| Structure of agents' state-dependent utility functions (D11) | Optimal bet's implementability (C61) |
| Buyer-seller asymmetry (L14) | Implementation of optimal bets (C61) |
| Increasing number of sellers (D49) | Feasibility of optimal bets (C61) |
| Agents' incentives to manipulate outcomes (D82) | Implementability of optimal bets (C61) |
| Distribution of priors (C46) | Agents' incentives to manipulate outcomes (D82) |