Ex Ante Price Commitment with Renegotiation in a Dynamic Market

This paper studies the endogenous determination of the price formation procedure in markets characterized by matchspecific heterogeneity; such heterogeneity captures, for example, markets in which sellers own differentiated commodities and buyers have heterogeneous preferences. Specifically, we study a dynamic, stochastic model of a market in which, in each time period, agents on one side (e.g., sellers) strategically choose whether or not to “post”, or commit themselves to, incomplete price contracts before they encounter agents of the opposite type. After a pair of agents of the opposite types have encountered each other, their match-specific values from trading with each other are realised. If no price contract was posted, then the terms of trade (and whether or not it occurs) are determined by bilateral negotiations. Otherwise,depending upon the agents’ match-specific trading values and equilibrium continuation payoffs, trade occurs (if it does) either on the terms specified in the posted contract or at a renegotiated price (when renegotiation of the posted, incomplete price contract is mutually beneficial ). We study the Markov subgame perfect equilibria of this market game, and address a variety of issues such as the impact of market frictions on the equilibrium proportion of trades that occur at a price specified in the ex-ante posted contract rather than at a price determined by ex-post bargaining.