A Competitive Theory of Equilibrium and Disequilibrium Unravelling in Two-Sided Matching

Abstract

I offer a competitive explanation for the rush toward early contracting in matching markets. The explanation does not rely on market power, strategic motives, or instability of the assignment mechanism. Uncertainty about workers' ability will produce inefficient matching if contracts are formed early. However, the insurance gain from early contracting may outweigh the loss from inefficient matching. If firms are risk neutral, it is the mediocre firms that will have the greatest incentive to offer early contracts. Opening up a market for early contracting will generally benefit the firms and hurt the workers. If firms are sufficiently risk averse, even the lowest-quality firms may want to offer early contracts, and a competitive equilibrium may not exist.

JEL Classification: D83