How Optimism Leads to Price Discovery and Efficiency in a Dynamic Matching Market

Abstract

We study a market search equilibrium with aggregate uncertainty, private information and heterogeneus beiefs. Traders initially start out optimistic and then update their beliefs based on their matching experience in the market, using the Bayes rule. It is shown that all separating equilibria converge to perfect competition in the limit as the time between matches tends to 0. We also establish existence of a separating equilibrium.Markets with search frictions, aggregate uncertainty, heterogeneous beliefs, optimism, bargaining, foundations of Walrasian equilibrium