Leonardo Felli and Kevin Roberts

Published 1 September 2011

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In an environment in which heterogenous buyers and sellers undertake ex-ante investments, the presence of market competition for matches provides incentives for investment but may leave inefficiencies that take the form of hold-up and coordination problems. This paper shows, using an explicitly non-cooperative model, that, when matching is assortative and investments precede market competition, buyers' investments are constrained efficient while sellers marginally underinvest with respect to what would be constrained efficient. However, the overall extent of this inefficiency may be large. Multiple equilibria may arise; one equilibrium is characterized by efficient matches but there can be additional equilibria with coordination failures.