Unravelling in Two-Sided Matching Markets and Similarity of PreferencesPublic Deposited
This study investigates the causes and welfare consequences of unravelling in two-sided matching markets. "Unravelling" arises when agents contract with one another at an early stage, before much of the relevant information is available. Such early matches may lead to ex-post inefficiencies and are perceived as socially harmful. This study shows that similarity of preferences is an important factor driving unravelling. In particular, under the ex-post stable mechanism (which is the mechanism the literature focuses on), unravelling occurs more often for more similar preferences. This is because when preferences are very similar, many firms are likely to prefer the same workers. Some firms would rather contract early, under uncertainty, than wait for the information and face the competition. This study also shows that unravelling leads to a loss of welfare. Thus, any Pareto-optimal mechanism must prevent unravelling. Moreover, the ex-post stable mechanism is Pareto-optimal if and only if it prevents unravelling. In markets where the ex-post stable mechanism unravels, there exist ex-post unstable Pareto-optimal mechanisms that stop unravelling and are preferable to the ex-post stable one.