Pre-Trade Private Investments

43 Pages Posted: 25 Feb 2019

Date Written: June 7, 2018

Abstract

This paper investigates the welfare effects of private investments prior to trade. A seller of a durable good can privately invest on changing its quality. After the investment, she receives a take-it-or-leave-it offer from a buyer. Both the seller and the buyer value more goods of higher quality. We obtain that, in equilibrium, the seller mixes the investment choice, adding adverse selection to the exchange. The non-observability of the investment lowers the buyer’s payoff without giving the seller additional rents. Adding buyer competition exacerbates the adverse selection and completely eliminates the trade surplus. Partial observability increases the equilibrium investment, makes the seller better off, and lowers the payoff of the buyer.

Keywords: Private Investment, Hold Up Problem, Price Dispersion

JEL Classification: D82, D83, D42, L15

Suggested Citation

Dilme, Francesc, Pre-Trade Private Investments (June 7, 2018). Available at SSRN: https://ssrn.com/abstract=3331163 or http://dx.doi.org/10.2139/ssrn.3331163

Francesc Dilme (Contact Author)

University of Bonn ( email )

Lennestrasse 35
53113 Bonn
Germany
0049228737957 (Phone)

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