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Market Signaling with Grades

43 Pages Posted: 9 Jan 2010 Last revised: 27 Mar 2014

Brendan Daley

Duke University - Fuqua School of Business

Brett S. Green

University of California, Berkeley - Haas School of Business

Date Written: September 13, 2013

Abstract

We consider a signaling model in which receivers observe both the sender's costly signal as well as a stochastic grade that is correlated with the sender's type. In equilibrium, the sender resolves the trade-off between using the costly signal versus relying on the noisy grade to distinguish himself. We derive a necessary and sufficient condition --- loosely, that the grade is sufficiently informative relative to the dispersion of (marginal) signaling costs across types --- under which the presence of grades substantively alters the equilibrium predictions. Specifically, separating equilibria do not survive stability-based refinements. Instead, the prediction depends on the prior distribution over the sender's type. For example, with two types it involves full pooling when the distribution places sufficient weight on the high type and partial pooling otherwise. Finally, the equilibrium converges to the complete-information outcome as the distribution tends to a degenerate one --- resolving a long-standing paradox within the signaling literature.

Keywords: Signaling, Asymmetric Information, Information Economics

JEL Classification: D82, D83, D41

Suggested Citation

Daley, Brendan and Green, Brett S., Market Signaling with Grades (September 13, 2013). Journal of Economic Theory, Vol. 151, No. 1, 2014. Available at SSRN: https://ssrn.com/abstract=1532846 or http://dx.doi.org/10.2139/ssrn.1532846

Brendan Daley

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States

Brett S. Green (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

2220 Piedmont Avenue
Berkeley, CA ca 94720
United States
5105759980 (Phone)

HOME PAGE: http://faculty.haas.berkeley.edu/bgreen/

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