Unraveling in Matching Markets

hao li, university of hongkong
sherwin rosen, university of chicago

Abstract

We use a two-period matching model with initial uncertainty about productivities of participants to analyze incentives for early contracting or unraveling. Unraveling provides insurance in the absence of complete markets, but causes inefficient assignments. Unraveling is more likely, the smaller the applicant pool, the smaller the proportion of more promising applicants, and the greater the heterogeneity in the pool. Banning early contracts hurts firms and benefits less promising applicants; the effects on more promising applicants depend on how the gains from early contracts are shared. Ex post buyouts eliminate inefficient assignments, and more promising applicants always unravel.