4.1 Signaling Theory - 2011

Motivation
Model
Equilibrium Analysis
Preference Signaling in Matching Markets

Peter Coles
Alexey Kushnir
1 Harvard
2 Penn
Muriel Niederle
Business School
State University
3 Stanford
Peter Coles, Alexey Kushnir, Muriel Niederle
University
Motivation
Model
Labor Markets
Employers confront hundreds of applications for a single job in

many labor markets.
Employers face two tasks:
1
2
Assess the quality of candidates (Spence, 1973)

Elicit the preferences of candidates
Signaling can guide employers in their decisions:

1
2
Quality signaling (Spence, 1973)

Preference signaling
Motivation
Model
Labor Markets
Employers confront hundreds of applications for a single job in

many labor markets.
Employers face two tasks:
1
2
Assess the quality of candidates (Spence, 1973)

Elicit the preferences of candidates
Signaling can guide employers in their decisions:

1
2
Quality signaling (Spence, 1973)

Motivation
Model
Signaling in Practice
Job market for new Ph.D. economists
each candidate can send signals up to two departments
signals are private
Informal preference signaling

the entry-level market for clinical psychologists, Roth and Xing
(1994)
Internet dating markets

virtual roses (www.cupid.com, www.hotornot.com)
Lee, Niederle, Kim and Kim (2009)
College admissions, Avery and Levin (2009)

early action and early decision
signal enthusiasm
Motivation
Model
When Can Signals Help?
In congested markets:
there is a limited period of time
candidates may begin accepting offers from other departments
offers are costly
...because of the arduous nature of the selection process, the
hiring of one young professor can cost a school from $10,000
to $15,000. (Mark Whitehouse, The Wall Street Journal,
January 8, 2007)
Motivation
Model
Novelty
Model of decentralized matching markets without

transfers, where signals transmit information about agent
preferences (i.e., preference signaling)
Motivation
Model
Main Contributions
The introduction of a signaling mechanism increases both

the expected number of matches
the welfare of agents on one side of the market
Value of a signaling mechanism under various market

structures
Signaling adds the most value for balanced markets
Additional periods of interaction between agents decrease the
impact of signaling
The optimal number of signals increases when agents who
send signals have more positions to fill
Motivation
Model
Main Contributions
The introduction of a signaling mechanism increases both

the expected number of matches
the welfare of agents on one side of the market
Value of a signaling mechanism under various market

structures
Signaling adds the most value for balanced markets
Additional periods of interaction between agents decrease the
impact of signaling
The optimal number of signals increases when agents who
send signals have more positions to fill
Motivation
Model
Outline
Literature review
A simple example
Model
Equilibrium analysis
Signals and agent welfare
Market structure and the value of a signaling mechanism

1
2
3
when is signaling most valuable?

optimal number of signals
many periods
Motivation
Model
Literature Review
Ability signaling
Spence (1973)
Avery and Levin (2009)
Lee and Schwarz (2007)
Abdulkadiroglu, Che, and Yasuda (2008)
Roth and Xing (1997),
Costless signaling
Crawford and Sobel (1982)
Motivation
Model
A Simple Example
2 firms and 2 workers

Preferences of firms are i.i.d. and
Pr (w1 fj w2 ) = Pr( w2 fj w1 ) =
1
2
Preferences of workers are i.i.d. and

Pr (f1 wi f2 ) = Pr( f2 wi f1 ) =
1
2
Cardinal utility of agent a

top choice 1
second choice x, 1 > x > 0
unmatched 0
Motivation
Model
A Market With Signals
Timing
1
Preferences are realized. Each worker sends up to one signal

to one firm. Workers send signals simultaneously.
Each firm makes up to one offer to one worker. Firms make

offers simultaneously.
Each worker chooses an offer to accept among available offers.
Equilibrium concept: sequential equilibrium (with refinement D1

of Cho and Kreps extended to our environment)
w4
A Market With Signals: w
Worker Strategies
5
Proposition
Motivation
Model
w4
w5
There are two types of symmetric sequential equilibria that satisfy

criterion D1:
Babbling equilibria
Equilibria where workers send their signals to their top firms
w
f1
f2
Motivation
Model
A Market With Signals: Firm Strategies
f1 workers send signals to top firms

Focus on equilibria where
w offer to better worker or offer to worker that

Firms tradeoff:
f2
more likely to accept
f
w1
w2
w1
w2
w1
w2
??
w1
w2
Motivation
2
Model
A Market With Signals:

Reduced
w1
w1 Game
f
respond=offer to
w2
2nd choice;
w1
w2
f1 \ f2
Respond
Ignore
w2
ignore=offer to 1st choice

??
w1
w2
Respond
x
0
Ignore
x
1/2 * 1
(respond, respond) is always an equilibrium

if firm 2 is responding, firm 1 must respond!
(ignore, ignore) is also an equilibrium if x < 0.5

Motivation
Model
Observations from our Simple Example
Respond-Respond
Firm Profits
(5 + 2x)/8
Worker Profits
3/4
# of Matches
7/4
Ignore-Ignore
3/4
(2 + x)/4
3/2
Firm strategies are strategic complements

if firm 2 responds more to signals, then firm 1 is weakly better
off from responding more to signals
Equilibrium ranking
(respond, respond) w (ignore, ignore)
(ignore, ignore) f (respond, respond)
# of matches in (respond, respond) > # of matches in
(ignore, ignore)
Motivation
Model
Observations from our Simple Example
Game with signals versus game without signals

msig mno
sig
(uw )sig (uw )no

(uf )sig (uf )no
sig
sig
Motivation
Model
Model
Model
Motivation
Model
Model
F firms, W workers
Ordinal preferences
f F firm f s preference list (strict)
w W worker w s preference list (strict)
f and w are i.i.d.
Cardinal utility of agent a

ua (, a ) > 0, consistent with a , ua (, a ) = 0
for any permutation , ua ( (f ), (w )) = ua (f , w )
Motivation
Model
Block Correlated Preferences

Firms
Workers
Block 1
f1
f2
Block 2
f3
f4
f5
Block 3
f6
f7
w1
w2
w3
w4
w5
w6
w7
w8
Motivation
Model
Block Correlated Preferences: Definition
B blocks of firms.
Firm preferences are uniformly distributed: f U(f ), i.i.d.
Workers preferences are block uniform:
1
For any b < b 0 , where b, b 0 {1, ..., B}, each worker prefers
every firm in Fb to any firm in Fb0 .
Each workers preferences within block Fb are uniform and
uncorrelated.
Motivation
Model
Agent Strategies
No-signal (no offer) option N

Workers strategy is
sw : w (F N )
last stage: worker w accepts the best offer
Firms strategy
sf : F 2W (W N )
Equilibrium concept: sequential equilibrium (with refinement

D1 of Cho and Kreps extended to our environment)
Motivation
Model
Assumptions
Definition Worker w s strategy sw is anonymous (neutral):

, w w , (s(w )) = s( (w )).
Definition Firm f s strategy sf is anonymous (neutral):
, f f , h W
(s(f , h)) = s( (f ), (h)).
where is some permutation of preference profiles.
OK: Always make offer to most preferred worker who sent
me a signal.
Ruled out: Always make offer to worker w2 .
Motivation
Model
Equilibrium analysis
Motivation
Model
Block-Symmetric Sequential Equilibria
Definition
Block-symmetric sequential equilibrium:
Firms that are within each block use the same anonymous
strategy and have the same beliefs.
All workers use the same anonymous strategy.
Motivation
Model
Block-Symmetric Sequential Equilibria
Characterization
Proposition
Let us consider any block-symmetric sequential equilibrium that
satisfies criterion D1. Then either
1
The equilibrium is a babbling equilibrium or
Workers use top-block strategies and firms have top-block

beliefs
Motivation
Model
Babbling Equilibrium
Babbling Equilibrium
Firms
f1
f2
f3
f4
f5
wi
f6
f7
Motivation
Model
Top-Block Equilibria
Top-block equilibria
Firms
f1
f2
f3
f4
f5
1
2
wi
3
f6
f7
Motivation
Model
Block-Symmetric Sequential Equilibria: Worker Strategies

q b (p b ) are the ex-ante probability of receiving an offer from
f Fb , conditional on (not) sending a signal to firm f .
b - the probability a worker sends her signal to block Fb .
Proposition
For any BSSE that satisfies criterion D1, either
1
for any b {1, ..., B}, q b = p b , or
there exists b0 {1, ..., B} such that q b0 > p b0 , and

for any b such that b > 0, we have q b > p b , and if a worker
sends her signal to block Fb , she sends her signal to her most
preferred firm within Fb , and
for any b 0 such that b0 = 0, workers strategies are optimal
0
for any off-equilibrium beliefs of firms from block F b .
Motivation
Model
Fix Worker Strategies, Firm Beliefs
We fix the worker strategies and firm beliefs:

Top-block strategies: Workers play a symmetric, top-block
strategy (1 , ..., B ).
b is the probability of sending a signal to top firm within
block Fb
Top-block firm beliefs: If firm f receives worker w s signal

its on- and off- equilibrium beliefs are that it is top worker w s
firm within block F b .
We now examine stage 2 behavior
Firm Strategies
w
3
Motivation
Model
Equilibrium
wAnalysis
4
w5
Each firm chooses between Tf and Sf .
f
w1
w2
w3
w4
w5
w3
w4
w5
Tf
Sf
Motivation
Model
Firm Strategies: Cutoff Strategies
f
w1
w2
w3
w4
w5
offer
f
w1
w2
w3
w4
w5
f
w1
w2
w3
w4
w5
offer
f
w1
w2
w3
w4
w5
f
Tf
w1
w2 Sf
Motivation
Model
Cutoff Strategies: Definition
Definition
Strategy sf is a cutoff strategy for firm f if j1 , . . . , jW [1, W ] :
for any f f and h W ,

S f (f ) if rankf (S f (f )) j|h|
s(f , h) =
T f (f ) otherwise.
Motivation
Model
Optimality of Cutoff Strategies
Proposition
For any strategy sf for firm f , there exists a cutoff strategy which
provides f weakly higher expected payoff than sf for any
anonymous strategies sf of opponent firms f .
Motivation
Model
Strategic Complements
Proposition
Suppose firms f use cutoff strategies. If firm f 0 f increases
its cutoffs (responds more to signals), firm f will also optimally
weakly increase its cutoffs.
Motivation
Model
Existence
Theorem
There exists a block-symmetric sequential equilibrium where
1
workers play symmetric, top-block strategies and
firms play block-symmetric, anonymous, cutoff strategies.
Motivation
Model
Signals and Agent Welfare
Signals and agent welfare
Motivation
Model
Welfare Comparison
Theorem
Consider any non-babbling block-symmetric sequential equilibrium
of the offer game with signals such that there is a block F b with
at least two firms, where workers send signals with positive
probability (b > 0). Then
E (m)
No signaling < Signaling
E (W workers )
No signaling < Signaling
E (W firms )
No signaling Signaling
Motivation
Model
Market Structure and the value of a signaling mechanism
Market structure and

the value of a signaling mechanism
Motivation
Model
Market Structure and the value of a signaling mechanism
Questions:
Large vs small markets: when is signaling most valuable?
Many periods of interactions
What is the optimal number of signals?
Motivation
Model
Pure Coordination Model
One block of firms, B = 1

Agents care only about obtaining a match
for any w W , f F , uw (f , w ) = uw > 0
for any w W , f F , uf (w , f ) = uf > 0
Motivation
Model
Balanced Markets
D(F , W ) - the expected % increase in the number of matches
from the introduction of the signaling mechanism
20%
W=10
D,%
D,%
20%
10%
0%
F=10
10%
0%
10
20
30
40
50
10
20
20%
20%
W=100
D,%
D,%
30
40
50
10%
0%
F=100
10%
0%
100
200
300
400
500
100
200
300
400
500
Motivation
Model
Balanced Markets
Balanced Markets
Proposition
For fixed W , D(F , W ) attains its maximum value at
F ' 1.0121W + OW (1).
For fixed F , D(F , W ) attains its maximum value at
W ' 1.8842F + OF (1).
Motivation
Model
Matching Markets with Multiple Periods
Matching markets with multiple periods
Motivation
Model
Multiple Periods
There are L periods of interactions.

Agents observe agents that match and leave the market.
Period 0. Workers send their signals.
Each worker sends one signal to some firm.
Periods 1, ..., L. Each period consists of two stages:

Each firm makes one offer to some worker.
Each worker can accept one offer from the set of offers she
receives.
Motivation
Model
Multiple Periods
The symmetric sequential equilibrium in the offer game with

signals
each worker sends her signal to her top firms;
each worker accepts the best available offer immediately
each firm always responds to signals
Motivation
Model
Multiple Periods
Proposition
In a market with F firms and W workers, the value of a signaling
mechanism D(F , W ) decreases with the number of periods of
interaction.
Motivation
Model
Multiple Periods: Simulation Results

Simulation results:
For the markets with F = W :
D is decreasing over L.
D decreases by 55% for L = 2
D decreases by 95% for L = 4
20%
D,%
15%
10%
5%
0%
1
Numberofperiods
Motivation
Model
Matching Markets with I Interviews and K Signals
Matching markets with
I interviews and K signals
Motivation
Model
Matching Markets with I Interviews and K Signals
Pure coordination model

One period of interaction
Each firm has one position to fill
Each worker has
I positions to fill, i.e., interviews
K identical signals to send
Motivation
Model
Simulation Results
Markets with I = 1 (solid), 2 (dashed), and 3(dot-dashed)
interviews, W = 100 workers and F = I 100 firms.
10
8
6
4
2
0
K 6
10
Motivation
Model
Summary
1
We have constructed a model of decentralized matching

markets without transfers, where signals
transmit information about agent preferences
alleviate coordination problem
We show that the introduction of a signaling mechanism

increases the expected number of matches,
increases the expected welfare of workers.
We show that the value of a signaling mechanism:

is the largest for balanced markets,
decreases with additional periods of interaction,
is optimized with an increasing number of signals as workers
have more positions to fill.

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Motivation

Preference Signaling in Matching Markets

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

Employers confront hundreds of applications for a single job in

Assess the quality of candidates (Spence, 1973)

Signaling can guide employers in their decisions:

Quality signaling (Spence, 1973)

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

Employers confront hundreds of applications for a single job in

Assess the quality of candidates (Spence, 1973)

Signaling can guide employers in their decisions:

Quality signaling (Spence, 1973)

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

Informal preference signaling

Internet dating markets

College admissions, Avery and Levin (2009)

Preference Signaling in Matching Markets

When Can Signals Help?

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

Model of decentralized matching markets without

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

The introduction of a signaling mechanism increases both

Value of a signaling mechanism under various market

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

The introduction of a signaling mechanism increases both

Value of a signaling mechanism under various market

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

Signals and agent welfare

Market structure and the value of a signaling mechanism

when is signaling most valuable?

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

2 firms and 2 workers

Preferences of workers are i.i.d. and

Cardinal utility of agent a

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

A Market With Signals

Preferences are realized. Each worker sends up to one signal

Each firm makes up to one offer to one worker. Firms make

Each worker chooses an offer to accept among available offers.

Equilibrium concept: sequential equilibrium (with refinement D1

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

There are two types of symmetric sequential equilibria that satisfy

A Market With Signals: Firm Strategies

f1 workers send signals to top firms

w offer to better worker or offer to worker that

Peter Coles, Alexey Kushnir, Muriel Niederle

Preference Signaling in Matching Markets

A Market With Signals:

ignore=offer to 1st choice

(respond, respond) is always an equilibrium

(ignore, ignore) is also an equilibrium if x < 0.5

Preference Signaling in Matching Markets