UC Irvine

While the usual paradigm of supply and demand in a frictionless market is useful for dis- cussing many issues, plenty of important questions are not easily addressed with this approach. In this dissertation I aim to further our understanding of markets where trading frictions are relevant from two different perspectives: a search-theoretic model and labora- tory experiments.

The first chapter of this dissertation focuses on a frictional labor market where firms can decide to replace current employees by randomly search for new candidates. I show that even in an economy where agents are risk neutral and face no liquidity constraints, severance payments emerge as part of an optimal contract when firms can search on-the-job. An optimal contract is composed of both the wage and a payment conditional on the worker being replaced. The size of the payment is chosen to allow the firm to internalize the externality associated so that firms take into account the total surplus effect of their replacement hire decisions. I add ex ante heterogeneity among workers which makes the pairwise optimal contract insufficient to achieve the constrained-efficient result (even under the Hosios condition) and then use a calibrated version of the model to illustrate that a lower on-the-job search cost can in fact reduce welfare.

In the second chapter, I develop an experimental framework to investigate price, output and welfare consequences of implementing the optimal monetary policy in a version of the search- theoretic money model of Lagos and Wright (2005): The Friedman Rule. I aim to further understand previous experimental results by Duffy and Puzzello (2022) which are somewhat at odds with the standard theory and contrary to the optimality of the rule vis-`a-vis an inflationary scheme, which they suggest could be rationalized on the basis of liquidity constraints and/or precautionary motives due to future price uncertainty. For this, I request subjects to make predictions about market prices and include a novel treatment for the decentralized goods market to try and mitigate price uncertainty: prices are exogenously imposed on consumers so they can only select from a fixed menu of quantities (and prices) when making an offer. My results tend to be consistent with previous experimental findings, but no clear evidence for the Friedman Rule emerges. Even when prices are fixed exogenously in pairwise meetings, evidence in favor is still only mixed and high volatility of prices in the centralized market persists. When using subjects own predictions about the centralized market price to look at how they expected to rebalance their holdings conditional on their beliefs there seems to be a clear bias: subjects mostly want to increase their token holdings regardless of previous trades.

In the third and last chapter, I use a semi-unstructured bargaining approach to experimentally study the effects of liquidity constraints on the determination of terms of trade. This setting is specially relevant for search-theoretic models of money: trade surplus and its di- vision are endogenously and simultaneously determined, with participants facing possible liquidity constraints due to buyer’s endogenous ex-ante choice of costly money holdings. My aim is to test the empirical relevance of two widely used axiomatic bargaining solutions: generalized Nash bargaining and Kalai’s proportional bargaining. Each bargaining solution predicts different outcomes and buyer’s anticipating their decision’s effect on the bargaining outcome may choose to additionally restrict their money holdings, which can prevent efficient outcomes from being achieved, even when money is costless to hold. A most relevant issue, since the protocol to determine terms of trade in monetary economies is critical for normative results, optimal monetary policy, and the welfare cost of inflation. By imposing different costs to holding money, I find strong evidence that costlier holdings do incentivize participants to economize on money holdings leading to a more constrained bargaining set resulting in less production and surplus, but find only mixed evidence in favor of any of the two bargaining solutions. Finally, I introduce two possible variations to the model that help better understand the data: myopic buyers and a sunk cost fallacy.