Search at the Margin

39 Pages Posted: 28 Jun 2015 Last revised: 2 May 2017

See all articles by Jose Carrasco

Jose Carrasco

Facultad de Ingeniería y Ciencias, Universidad Adolfo Ibañez

Lones Smith

University of Wisconsin at Madison - Department of Economics

Date Written: April 28, 2017

Abstract

We formulate and solve dynamic programming models extending search theory to (1) multiple indivisible units and (2) perfectly divisible assets. Buyers arrive seeking randomly many units at a random price in (1), or with a random limit order in (2). The seller can partially exercise orders - hence, search at the margin.

The optimal selling strategy adjusts as the asset position falls, reflecting the endogenous holding costs: i.e. the opportunity cost of delaying optionality for the inframarginal units. This depresses reservation prices at the margin. For instance, model (1) subsumes the wage search model, but we inductively argue that the seller is willing to accept less and less money for each additional unit he sells.

While we use induction for the indivisible units model (1), our analysis of continuously divisible assets in (2) exploits recursion and contraction methods. We characterize three derivatives of the Bellman value function. It is firstly increasing and strictly concave. Thus, the seller takes greater advantage of more generous offers, and his marginal value shifts up as he unwinds his position, making him less willing to trade. Next, with a falling purchase cap density, the marginal value is strictly convex, and so the seller's supply response is less elastic at higher prices.

Our model is readily amenable to price-quantity bargaining. We show that greater buyer bargaining power has the same effect as greater search frictions.

Keywords: Search Theory, Dynamic Programming

JEL Classification: D83, G14

Suggested Citation

Carrasco, Jose and Smith, Lones, Search at the Margin (April 28, 2017). American Economic Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2623839 or http://dx.doi.org/10.2139/ssrn.2623839

Jose Carrasco

Facultad de Ingeniería y Ciencias, Universidad Adolfo Ibañez ( email )

2640, Peñalolen
Santiago
Chile

HOME PAGE: http://www.tonocarrasco.com

Lones Smith (Contact Author)

University of Wisconsin at Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706-1393
United States
608-263-3871 (Phone)
608-262-2033 (Fax)

HOME PAGE: http://www.lonessmith.com

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