Screening with an Approximate Type Space

38 Pages Posted: 19 Jul 2010

See all articles by Kristof Madarasz

Kristof Madarasz

London School of Economics & Political Science (LSE)

Andrea Prat

Columbia Business School - Finance and Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2010

Abstract

We re-visit the single-agent mechanism design problem with quasilinear preferences, but we assume that the principal knowingly operates on the basis of only an approximate type space rather than the (potentially complex) truth. We propose a two-step scheme, the profit-participation mechanism, whereby: (i) the principal `takes the model seriously' and computes the optimal menu for the approximate type space; (ii) but she discounts the price of each allocation proportionally to the profit that the allocation would yield in the approximate model. We characterize the bound to the profit loss and show that it vanishes smoothly as the distance between the approximate type space and the true type space converges to zero. Instead, we show that it is not a valid approximation to simply act as if the model was correct.

Keywords: computational complexity, mechanism design, model uncertainty, nonlinear pricing, screening

JEL Classification: D82

Suggested Citation

Madarasz, Kristof and Prat, Andrea, Screening with an Approximate Type Space (June 2010). CEPR Discussion Paper No. DP7900, Available at SSRN: https://ssrn.com/abstract=1640977

Kristof Madarasz (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Andrea Prat

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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