Allocation Mechanisms in Decentralized Exchange Markets with Frictions

TL;DR

This paper examines how transfer frictions in decentralized exchange markets impact allocation efficiency, characterizes mechanisms that handle such costs, and relates findings to risk sharing literature.

Contribution

It introduces an axiomatic framework for allocation mechanisms considering transfer frictions and characterizes robust linear and conditional mean mechanisms.

Findings

Frictional transfer costs are akin to subadditivity of transfer costs.

Characterization of robust linear allocation mechanisms.

Introduction of Robust Conditional Mean Allocation mechanisms.

Abstract

The classical theory of efficient allocations of an aggregate endowment in a pure-exchange economy has hitherto primarily focused on the Pareto-efficiency of allocations, under the implicit assumption that transfers between agents are frictionless, and hence costless to the economy. In this paper, we argue that certain transfers cause frictions that result in costs to the economy. We show that these frictional costs are tantamount to a form of subadditivity of the cost of transferring endowments between agents. We suggest an axiomatic study of allocation mechanisms, that is, the mechanisms that transform feasible allocations into other feasible allocations, in the presence of such transfer costs. Among other results, we provide an axiomatic characterization of those allocation mechanisms that admit representations as robust (worst-case) linear allocation mechanisms, as well as those mechanisms that admit representations as worst-case conditional expectations. We call the latter Robust Conditional Mean Allocation mechanisms, and we relate our results to the literature on (decentralized) risk sharing within a pool of agents.