Brendan Daley

Waiting for News in the Market for Lemons

We study a dynamic setting in which stochastic information about the value of a privately-informed seller’s asset is gradually revealed to a market of buyers. We characterize the unique equilibrium in a continuous-time framework. The equilibrium involves periods of no trade or market failure. The no-trade period ends in one of two ways: either enough good news arrives restoring confidence and markets re-open, or bad news arrives making buyers more pessimistic forcing market capitulation i.e., a partial sell-off of low-value assets. Reservation values arise endogenously from the option to sell in the future. Our model encompasses both lemons and signaling environments - in a dynamic setting with sufficiently informative news, the two environments have the same equilibrium structure.

Market Signaling with Grades

We consider a signaling model in which receivers observe both the senders costly signal as well as a stochastic grade that is correlated with the senders 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 senders 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.

Efficient investment in a dynamic auction environment

We analyze an environment in which biddersʼ private values change over time due to both private investments and exogenous shocks. We demonstrate that a highly-decentralized mechanism achieves efficiency. The mechanism requires a stage of costly public announcements (i.e., signaling) to induce efficient investment. For this reason, an equilibrium selection issue arises, but can be handled by a minor modification in the spirit of virtual implementation.

Foundations for Cooperation in the Prisoners’ Dilemma

We provide axiomatic foundations for a simple model of play in the prisoners’ dilemma. The model accommodates cooperation and suggests that players behave as if their expectations about their opponents’ behavior vary with their own choice. We refer to this nonstandard updating as magical thinking. The degree to which players exhibit magical thinking may be heterogeneous in the population and is captured by a uniquely identified parameter for each player. Further, it is as if all players perceive these parameters to be i.i.d. draws from a common distribution. The model’s identification allows for tractable comparative statics.

When to Release Feedback in a Dynamic Tournament

We study dynamic tournaments in which time is modeled explicitly, as opposed to with the abstract notion of “periods.” By doing so, we characterize the effects of the ex ante designated timing of an interim progress report. Whether or not a policy of reporting increases total expected effort does not depend on the release time of the report; however, the magnitude of the effect does. We demonstrate that total expected effort is single peaked or single troughed in the report’s release time depending on parameters, with the peak/tough located at a time strictly more than halfway through the tournament. However, a policy of releasing information always harms the expected utility of the tournament’s participants. Implications for tournament design are discussed.

Bargaining and News

We study a bargaining model in which a buyer makes frequent offers to a privately informed seller, while gradually learning about the seller’s type from “news.�? We show that the buyer’s ability to leverage this information to extract more surplus from the seller is remarkably limited. In fact, the buyer gains nothing from the ability to negotiate a better price despite the fact that a negotiation must take place in equilibrium. During the negotiation, the buyer engages in a form of costly “experimentation�? by making offers that are sure to earn her negative payoffs if accepted, but speed up learning and improve her continuation payoff if rejected. We investigate the effects of market power by comparing our results to a setting with competitive buyers. Both efficiency and the seller’s payoff can decrease by introducing competition among buyers.

Securitization, Ratings, and Credit Supply

We develop a framework to explore the effect of credit ratings on loan origination and securitization. In the model, banks privately screen and originate loans and then issue securities that are backed by loan cash flows. Issued securities are rated and sold to investors. Without ratings, banks with good loans retain a portion of them to signal quality to investors. With informative ratings, banks rely less on costly retention and more on public information. Moreover, when ratings are sufficiently accurate, banks may eschew retention altogether and simply originate to distribute (OTD). Thus, ratings endogenously shift the economy from a Signaling equilibrium with inefficient retention towards an OTD equilibrium with inefficiently low lending standards. Ratings therefore increase overall efficiency provided the reduction in costly retention more than compensates for the origination of some negative NPV loans. We study how banks ability to screen loans affects these predictions, and use the model to analyze commonly proposed policies such as mandatory “skin in the game.�?

Security Design with Ratings

We investigate the effect of public information, such as ratings, on the security design problem of a privately informed issuer. We show that the presence of ratings has important implications for both the form of security designed and the amount of inefficient retention. The model predicts that issuers will design informationally sensitive securities (i.e., levered equity) when ratings are sufficiently informative relative to the gains from trade. Otherwise, issuers opt for a standard debt contract. In either case, informative ratings increase market liquidity by decreasing the reliance on inefficient retention to convey high quality, and perhaps counterintuitively, decrease price informativeness.

Supplement to: 'Foundations for Cooperation in the Prisoners’ Dilemma'

We establish that in the Prisoners’ Dilemma, the model of Daley and Sadowski (2013) is logically distinct from three models that employ well-known forms of other regarding preferences - altruism (Ledyard, 1995; Levine, 1998), inequity aversion (Fehr and Schmidt, 1999), and reciprocity (Rabin, 1993).