Optimal Dynamic Matching
Transcription
Optimal Dynamic Matching
Optimal Dynamic Matching Mariagiovanna Baccara SangMok Leey Leeat Yarivzx May 19, 2015 Abstract We study a dynamic matching environment where individuals arrive sequentially. There is a tradeo¤ between waiting for a thicker market, allowing for higher quality matches, and minimizing agents’ waiting costs. The optimal mechanism cumulates a stock of mismatched pairs up to a threshold and matches all others in an assortative fashion instantaneously. In decentralized settings, a similar protocol ensues in equilibrium, but expected queues are ine¢ ciently long. We quantify the welfare gain from centralization, which can be substantial, even for low waiting costs. We also evaluate welfare improvements generated by transfer schemes and by matching individuals in …xed time intervals. Keywords: Dynamic Matching, Mechanism Design, Organ Donation, Market Design. Olin School of Business, Washington University in St. Louis. E-mail: [email protected] Department of Economics, University of Pennsylvania. E-mail: [email protected] z Division of the Humanities and Social Sciences, Caltech. E-mail: [email protected] x We thank Larry Samuelson for very helpful comments. We gratefully acknowledge …nancial support from the National Science Foundation (SES 0963583). y 1 Introduction 1.1 Overview Many matching processes are inherently dynamic, with participants arriving and matches being created over time. According to the Organ Donation and Transplantation Statistics, a new patient is added to the kidney transplant list every 14 minutes and about 3000 patients are added to the kidney transplant list each month. A signi…cant fraction of these patients arrive at the list with a living donor – in 2013, about a third of nearly 17; 000 kidney transplants that took place in the US involved such donors. A similar picture emerges when considering child adoption. According to the Census 2000, about 1:6 million or 2:5 percent of all children were adopted. The precise statistics on the entry of parents and children into the process are poorly documented. However, data from one US adoption facilitator who links adoptive parents and children indicates a rate of about 11 new potential adoptive parents and 13 new children entering the facilitator’s operation each month.1 Likewise, many labor markets entail unemployed workers and job openings that become available at di¤erent periods – the US Bureau of Labor Statistics reports approximately …ve million new job openings and slightly fewer than …ve million newly unemployed workers each month this year. Nonetheless, by and large, the extant matching literature has taken a static approach to market design – participants all enter at the same time and the market’s operations are restricted in their horizon (see the literature review below for several notable and recent exceptions). In the current paper, we o¤er techniques for extending that approach to dynamic settings. All of the examples we mentioned above share two important features. First, the quality of matches varies. In other words, agents care about whom they match with. Second, waiting for a match is costly, be it for …nancial costs of keeping lawyers on retainer for potential adoptive parents, children’s hardship from growing older in the care of social services, the lack of wages and needed employees in labor markets, or medical risks for organ patients and psychological waiting costs for donors. These two features introduce a Some crucial trade-o¤ – on the one hand, a thick market can help generate a greater match surplus; on the other hand, 1 This adoption facilitator is one of 25 registered in its state of operation. See Baccara, Collard-Wexler, Felli, and Yariv (2014) for details. 1 instantaneous matching cuts down on waiting costs. The goal of this paper is to characterize the resolution of this trade-o¤ in both centralized and decentralized environments. Namely, we identify the optimal protocol by which a social planner would match agents over time. We also identify the conditions under which decentralized matching processes would especially bene…t from such centralized intervention. Speci…cally, we consider a market that evolves dynamically. There are two classes of agents, which we refer to as squares and rounds. At each period, a square and round pair enters the market. Squares and rounds each have two types, one type more appealing to the other side than the other. For instance, if we think of squares and rounds as children relinquished for adoption and potential adoptive parents, types can stand for gender of children and wealth levels of potential adoptive parents, respectively (see Baccara, Collard-Wexler, Felli, and Yariv, 2014). Alternatively, if we think of the two classes of agents as patients and donors, types can represent age, and both younger patients and younger donors are more appealing than older patients or donors (see, e.g., Gjertson, 2004 and Oien et al., 2007). We assume that preferences are super-modular so that the (market-wide) assortative matching maximizes joint welfare. We also assume that, once agents arrive at the market, waiting before being matched comes at a per-period cost. We start by analyzing the optimal matching mechanism in such settings. We show that the optimal mechanism takes a simple form. Whenever congruent pairs of agents are present in the market (i.e., a square and round that are both of the more appealing type or the less appealing type), they are matched instantaneously. When only mismatched agents are present in the market (i.e., a square and a round of the more appealing and less appealing type, or vice versa), they form a queue. When the stock of pairs in the queue exceeds a certain threshold, mismatched pairs are matched in sequence, until the queue length falls within the threshold. Such thresholds induce a Markov process, where states correspond to the length of queues of mismatched pairs of agents. Any threshold yields a di¤erent steady-state distribution over possible queue lengths, and we evaluate the expected welfare of the mechanism in the steady-state. The optimal mechanism utilizes the threshold that maximizes welfare. When waiting costs are vanishingly small, the welfare under the optimal mechanism approaches the maximum feasible, that generated by no matches of mismatched pairs. Nonetheless, as time frictions, or waiting costs increase, the welfare generated by the optimal mechanism decreases. 2 This welfare decrease raises the question of the value of dynamic clearinghouses for nontrivial waiting costs in di¤erent environments, identi…ed by type distributions and preferences. We therefore study the performance of a simple decentralized matching process in our setting. As before, we consider agents arriving at the market in sequence. At each period in which they are on the market, agents declare their willingness to match with partners of either type. After these demands have been made, the maximal number of pairs of willing agents are matched in order of arrival.2 Those who prefer to stay in the market, or have to stay for lack of willing partners, form a queue.3 In our environment, individuals waiting in the market impose a negative externality on those who follow them in the queue, as they force them to wait a longer period and potentially miss appealing matches. This negative externality, which is not internalized by individuals, leads to excessive waiting in the decentralized setting. In fact, the matching protocol induced by equilibrium in the decentralized matching process ends up resembling the protocol corresponding to the optimal mechanism, but with higher thresholds for the queues’lengths. We evaluate the welfare wedge between a centralized and a decentralized market as a function of the underlying primitives of the environment, namely the agents’type distribution and the cost of waiting. As the frequency of desirable types on either side of the market increases, the option value of waiting becomes higher. The negative externalities imposed by agents waiting in the decentralized setting lead to the welfare di¤erential between the two processes increasing. This suggests greater bene…ts from market intervention. The comparative statics with respect to costs of waiting are more subtle. An increase in the cost of waiting has two e¤ects. On the one hand, for any …xed queue length, agents experience greater waiting costs. Since expected queues are longer in the decentralized setting, this e¤ect elevates the welfare di¤erential between the decentralized and optimal processes. On the other hand, both the optimal threshold as well as the equilibrium threshold in the decentralized process decrease as a function of waiting costs. Since in the decentralized setting higher costs reduce the incentives to wait, and therefore the negative externalities imposed on longer queues, this indirect e¤ect works to mute the welfare di¤erence between the two 2 This process is reminiscent of a double auction, as each agent submits a “demand function” specifying which types of agents she would be interested in matching with immediately. 3 We provide a characterization of preferences that assure that the process is individually rational for all participants. 3 processes. We show that the combination of these e¤ects leads to a welfare wedge that is locally increasing in costs (formally, it is piece-wise increasing), but exhibits a general decreasing trend. Ultimately, when costs are prohibitively high, both processes lead to instantaneous matches and identical welfare levels. Finally, we ask in which ways one can improve upon decentralization with interventions that are simpler than the full-‡edged optimal mechanism. Indeed, centralization may be hard to implement for two main reasons: …rst, it requires the central planner to be able to force matches upon individuals and, second, it requires the central planner to monitor arrivals and to possibly create matches at every period, yielding potentially high administrative costs. To address the …rst issue, we consider a decentralized setting in which per-period taxes are introduced for the agents that decide to wait. Our characterization of the optimal mechanism allows us to identify a budget-balanced tax scheme that implements the optimal levels of welfare. Such a tax scheme can be tailored so that it does not distort agents’incentives to enter the market to begin with. Nonetheless, even such a taxation plan may be viewed as cumbersome from an administrative perspective as it entails the collection or distribution of resources that depend on agents’location in the queue. To address this problem, as well as avoid administrative costs due to market intervention at every period, we also analyze the performance of a simple mechanism in which all matches occur at …xed time intervals. The length of these time intervals can be chosen to balance the costs of waiting and the quality of the resulting matches, which we characterize. We show that such a simple procedure can improve welfare substantially relative to full decentralization, though is still inferior to the fully optimal matching mechanism. 1.2 Related Literature The interest surrounding dynamic matching is quite recent and the literature on this topic is still relatively limited. Much of this literature originally stemmed from the organ donation application. Zenios (1999) develops a queueing model to explain the di¤erences between waiting times of di¤erent categories of patients anticipating a kidney transplant. In the context of kidney exchange, Ünver (2010) focuses on a market in which donors and recipients arrive stochastically, preferences are compatibility-based, and the goal of a central planner is to minimize total discounted waiting costs. Under some conditions, he shows that the e¢ cient 4 two-way matching mechanism always carries out compatible bilateral matches as soon as they become available. However, when multi-way matches are possible, some two-way matches could be withheld in order to allow future multi-way matches.4 Akbarpour, Li, and Oveis Gharan (2014) is possibly the closest to our study as they also inspect the bene…ts of di¤erent mechanisms in a dynamic two-sided matching environment. In their setting, however, preferences are compatibility-based according to a network mapping the set of exchange possibilities. Agents in the system (thought of as patient-donor pairs) become “critical” at random dates, and perish immediately after if they remain unmatched. Therefore, when waiting costs are negligible, the goal of the planner is to minimize the number of perished agents. Market thickness is bene…cial in that it guarantees the availability of immediate matches for agents who become critical. Left to their own devices, agents in that setting would match quickly and useful mechanisms induce agents to wait. In contrast, in our setting, agents in a decentralized process wait too long and useful mechanisms induce agents to wait shorter times on the market. In addition, while the welfare benchmark in Akbarpour, Li, and Oveis Gharan (2014) is that of an omniscient planner, our di¤erent focus allows us to characterize the optimal mechanism, which serves as the benchmark for welfare comparisons. In a somewhat di¤erent realm, Leshno (2014) studies a one-sided market in which objects (say, public houses) need to be allocated to agents who wait in a queue. Welfare maximization always requires agents to be matched to their preferred objects. However, if agents’preferences are unknown to the planner and their preferred item is in short supply, agents may prefer a mismatched item earlier to avoid costly waiting. Leshno (2014) shows that the welfare loss from mismatches can be reduced substantially through a policy under which all agents who decline a mismatched item face the same expected wait for their preferred item.5 Anderson, Ashlagi, Gamarnik, and Kanoria (2014) study an environment in which each agent is endowed with an item that can be exchanged with an item owned by someone else. Compatibility is stochastic, and three classes of feasible exchanges are considered: two-way exchanges only, two- and three-way cycles, and any kind of chain. They …nd that a policy that maximizes 4 Some recent models in inventory control have a similar ‡avor to the compatibility-based matching process considered by Ünver (2010), see e.g. Gurvich and Ward (2014). 5 Bloch and Cantala (2014) also study dynamic allocations. In their setting, a mechanism is a probability distribution over all priority orders consistent with the waiting list. Given a priority order, whenever a new object becomes available, agents are proposed the object in sequence and can either accept or reject. They show the bene…ts of a strict seniority order. 5 immediate exchanges without withholding them in the interest of market thickness performs nearly optimally.6;7 In yet another context, Budish, Cramton, and Shim (2015) consider …nancial exchanges and argue that high-frequency trading leads to ine¢ ciencies, while frequent batch auctions, uniform-price double auctions that occur at …xed and small time intervals, can provide e¢ ciency improvements. These results are reminiscent of our observations regarding the welfare improvements generated by matchings that occur at the end of each …xed window of time. There is also a recent theoretical literature that considers decentralized matching processes that are dynamic, considering both informational and time frictions (see, e.g., Haeringer and Wooders, 2011, Niederle and Yariv, 2009, and Pais, 2008). In that literature, the number of agents on each side of the market is …xed at the outset and agents on one side can make directed o¤ers to agents on the other side. The main goal is the identi…cation of market features that guarantee that an equilibrium of the induced game generates a stable matching. Another related strand of literature is the search and matching literature (e.g., Burdett and Coles, 1997, Eeckhout, 1999, and the survey by Rogerson, Shimer, and Wright, 2005). There, each period, workers and …rms randomly encounter each other, observe the resulting match utilities, and decide jointly whether to pursue the match and leave the market or to separate and wait for future periods. As time frictions vanish, such markets generate outcomes that are close to a stable matching. A crucial di¤erence with our setting is the stationarity of the market –the perceived distribution of potential partners does not change with time, and each side of the market solves an option value problem.8 Last, there is a rather large literature that considers dynamic matching of buyers and sellers and inspects protocols that increase e¢ ciency or allow for Walrasian equilibrium outcomes to emerge as agents become increasingly patient (see, e.g., Satterthwaite and Shneyerov, 2007 and Taylor, 1995). 6 On the bene…ts of algorithms that create thicker pools in sparse dynamic allocation environments, see also Ashlagi, Jaillette, and Manshadi (2013). 7 While most of this literature has been focusing on the design of algorithms to achieve socially desirable matchings Doval (2014) introduces a notion of stability in dynamic environments, and provides conditions under which dynamically stable allocations exist. 8 In the context of marriage markets, Kocer (2014) considers learning over time and models the choice of temporary interactions with di¤erent potential partners as a multi-armed bandit problem. Choo (2015) develops a new model for empirically analyzing dynamic matching in the marriage market and applies that model to recent changes in the patterns of US marriages. 6 2 Setup We study an in…nite-horizon dynamic matching market. There are two kinds of agents: squares and rounds. Squares and rounds can stand for potential adoptive parents and children relinquished for adoption, workers and employers, patients and donors, etc.9 At each time t, one square and one round arrive at the market. Each square can be of either type A or B with probability p or 1 or with probability p or 1 p, respectively, and each round can be of type p, respectively. These types correspond to the attributes of participants – they can stand for the wealth of parents and race of children in the adoption application, level of education and wages or interest of employers in labor markets, age or tissue types in the organ donation context10 , etc. In our model, squares seek to match with rounds and vice versa. We denote by Ux (y) the surplus for a type-x participant from matching with a type-y participant. We assume that A-squares are more desirable for all rounds and that -rounds are more desirable for all squares. That is, UA ( ) > UA ( ); UB ( ) > UB ( ); U (A) > U (B); U (A) > U (B): It will be convenient to denote: UA UB UA ( ) + U (A); UB ( ) + U (B); UA UB UA ( ) + U (A); UB ( ) + U (B); as well as U UA + UB UA UB : We will further assume that U > 0 so that the utilitarian e¢ cient matching in a static market matches the maximal number of (A; ) and (B; ) pairs. The value of U captures the e¢ ciency gain from the assortative matching relative to the anti-assortative matching. Notice 9 The organ donation application shares some features of our model when considering live donations from good samaritan donors, in which case the matching process is two-sided in nature. 10 This is a simpli…ed representation that aims at capturing heterogeneity in types and the quality of di¤erent matches it implies. For organ donation, patients and donors are often classi…ed into coarse categories based on age. However, more than two tissue types are often considered. For example, for kidney transplantation, the medical community currently looks at six tissue types, called major histo-compatibility complex or HLA antigens. 7 that if we assumed fully symmetric utilities, Ux (y) = Uy (x), U > 0 would be tantamount to assuming super-modular assortative preferences (a-la Becker, 1974) and U can be thought of as the degree of super-modularity preferences exhibit. We assume that each square and round su¤er a cost c > 0 for each period they spend on the market waiting to be matched. We also assume that agents leave the market only by matching. In Section 7.1 we provide bounds on the utility of agents from remaining unmatched that assures this assumption is consistent with individual rationality in the processes we analyze.11 Several assumptions merit some discussion. The assumptions of super-modular preferences and waiting costs that are identical for both sides of the market are made for presentation simplicity. Both of these assumptions are common in the literature and, as we describe in Section 5, lead to a conservative comparison of the optimal and decentralized matching protocols. The assumption that the distribution of types of rounds mirrors that of squares also simpli…es our analysis substantially as will be seen. It essentially implies that if we drew a large population of rounds and squares, the realized distributions of types would be approximately balanced with high probability. This may be a fairly reasonable assumption for certain applications, such as organ donation. Indeed, the distribution of tissue types of donors and patients is arguably similar. Furthermore, the age of a donor is known to have a strong impact on the expected survival of a graft (see, e.g., Gjertson, 2004 and Oien et al., 2007) and younger recipients have been suggested as the natural recipients of higher-quality organs (see Stein, 2011). Our assumptions then …t a world in which the classi…cation of patients and donors into “young” or “mature” categories is similar. Our assumption also approximately holds for certain attributes in the online dating world (see Hitch, Hortacsu, and Ariely, 2010). Nonetheless, it might be a rather harsh assumption for other applications. In Section 7.2 we discuss how the techniques we introduce can be used were we to relax that assumption. We replicate some of our analysis for general asymmetric settings in the Online Appendix. The other strong assumption we make is that a pair of agents arrives at the market in each period. The analysis would remain virtually identical were we to assume that pairs arrive at random times following, say, a Poisson distribution. However, the assumption that 11 We show that individual rationality is guaranteed when all agents are acceptable and when any -round receives a utility lower than U (B) 1 p p [U (A) U (B)] when leaving the market unmatched (analogously for B-squares). 8 participants arrive in pairs is important for the techniques we use. This assumption assures that the market is balanced throughout the matching process. It is a reasonable assumption for some applications. For example, in the adoption process presumably potential adoptive parents and children make important decisions (whom to match with, whether to leave the process, etc.) at spaced-out intervals. Given the limited variability in the volume of entrants on a monthly basis, the assumption of balanced arrivals provides a decent approximation of reality.12 This assumptions also approximately holds in certain labor markets. Indeed, Hall and Kruger (2012) suggest that a large fraction of jobs have posted wages. Naturally, these wages may re‡ect general equilibrium wages tailored to the precise composition of the market. Nonetheless, the fact that wages do not ‡uctuate dramatically suggests that the distributions of agents is fairly stable. Allowing for di¤erent arrival rates on both sides of the market introduces new considerations as matching participants in thin markets, while still entailing low waiting costs, imposes now a loss in terms of both the quality of matches and the number of individuals matched. The extensions to di¤erent arrival rates is therefore left for the future. 3 Optimal Dynamic Matching 3.1 The Matching Process In this section we characterize the socially optimal dynamic mechanism. At each period, after a new square-round pair arrives, the social planner determines which matches to implement, if any, to maximize the aggregate social welfare. At any time t, before a new square-round pair enters the market, a queue corresponds to a vector (kA ; kB ; k ; k ), where each argument is the stock of squares or rounds of each type waiting in line from the previous period. It is immediate to see that an optimal mechanism would match an A-square and an - round whenever both are available, since having both in the queue only imposes waiting costs.13 Also, when both a B-square and a -round are available, an optimal mechanism would match them immediately. The only reason to maintain a B-square in the queue is to 12 Our results extend directly if we assume that each period a …xed number of square-round pairs (possibly greater than one) enter the market. 13 As waiting costs are linear, the identity of those matched has no welfare implications. 9 match her with an -round, and similarly the only reason to keep a -round in the queue is to match him with an A-square. However, because of our super-modularity assumption, if such matches are to be possible, they would be inferior to the (B; ) and (A; ) matches that would then be feasible instead. Matching a B-square and a -round immediately therefore generates at least as high ultimate match surplus and entails a lower waiting cost. Therefore, we have the following: Lemma 1. Any optimal mechanism requires (A; ) and (B; ) pairs to be matched as soon as they become available. The lemma implies that at any point in time an optimal dynamic mechanism entails queues of only A-squares and -rounds or only B-squares and -rounds. That is, the queue can take the form of either (k; 0; 0; k) or (0; k; k; 0); for some k 0: The optimal dynamic mechanism is then identi…ed by the maximal stock of A-squares (and -rounds) and the maximal stock of -rounds (and B-squares) that are kept waiting. In the following proposition we characterize the structure of the optimal mechanism. Proposition 1 (The Optimal Mechanism). An optimal dynamic mechanism is identi…ed by a pair of thresholds (kA ; k ) 2 Z+ such that 1. whenever more than kA A-squares are present, kA kA pairs of type (A; ) are matched immediately, and 2. whenever more than k -rounds are present, k k pairs of type (B; ) are matched immediately. From the symmetry of our environment, an optimal mechanism corresponds to symmetric thresholds: k = kA = k :14 A dynamic mechanism with symmetric thresholds (k; k) as de…ned in Proposition 1 is depicted in Figure 1, where kA = kA k captures the di¤erence between the length of the queue of A-squares and the length of the queue of -rounds. We call kA the (signed) length of the A- queue. Agents of congruent types who enter the market lead to no change in the queue lengths, whereas mismatched pairs can change the queue length, unless the threshold is reached. 14 In Section 7.2 we describe the extension to asymmetric environments, where the two thresholds may di¤er. 10 Figure 1: Structure of Optimal and Decentralized Matching Processes This process induces the following Markov chain. Let st denote the number of A-squares (or -rounds) minus the number of -rounds (or B-squares) – that is the value of kA – at the beginning of time t; before the arrival of a new square-round pair. If an (A; ) or a (B; ) pair arrive in period t, the mechanism matches an (A; ) or a (B; ) pair immediately, and the state remains the same: st = st+1 . Suppose an (A; ) pair arrives in period t. As long as 0 st < k, the mechanism creates no matches and st+1 becomes st + 1. If st < 0, the mechanism creates one (A; ) match and one (B; ) match, and st+1 becomes st + 1. Finally, if st = k, the mechanism creates one (A; ) pair, and st+1 remains the same, st+1 = st = k. Analogous transitions occur with the arrival of a (B; ) pair. Therefore, we can describe the probabilistic transition as follows. Denote by xt (xtk ; xtk 1 ; :::; xt k+1 ; xt k )tr 2 f0; 1g2k+1 the timed vector capturing the state, xti = 1(st = i) –that is, xti is an indicator that takes the value of 1 if the state is st and 0 otherwise. Then, xt+1 = Tk xt ; where 0 B B B B B Tk = B B B B @ 1 p(1 p) p(1 p) p(1 p) 1 2p(1 p) 0 p(1 p) .. .. . . 0 0 0 0 ::: ::: ::: ... 0 0 0 0 .. . .. . 0 ::: p(1 p) : : : 1 2p(1 p) p(1 p) ::: p(1 p) 1 p(1 p) 11 1 C C C C C C: C C C A (1) The above Markov chain is ergodic (i.e., irreducible, aperiodic, and positively recurrent). Therefore, an optimal mechanism corresponds to a matching process that reaches a steady state with a unique stationary distribution. For Tk , the steady-state distribution is uniform so that each state s = k; k 3.2 1; : : : ; k occurs with an equal 1 2k+1 probability. Optimal Thresholds In order to characterize the optimal threshold, we …rst evaluate the welfare corresponding to any arbitrary symmetric threshold. First, we compute the average total waiting costs incurred by agents waiting in line for one period of time. During the transition from time t at state s to time t + 1, 2jsj agents wait in line. So the total costs of waiting incurred during this one time period is 2jsjc. Thus, a mechanism with threshold k results in expected total costs of waiting equal to 0 1 k X 1 @ 2k(k + 1)c 2jsjA c = : 2k + 1 2k + 1 s= k Next we compute the average total surplus generated during one time period, tracking the Markov process described above. A new arrived pair is of type (A; ) with probability p2 , in which case the optimal mechanism generates a surplus equal to UA . Similarly, when a new pair of type (B; ) arrives, which occurs with probability (1 p)2 , the optimal mechanism generates a surplus equal to UB . Suppose an (A; ) pair arrives. If st < 0, the mechanism creates one (A; ) and one (B; ) pair, generating a surplus equal to UA + UB . If 0 st < k, the mechanism creates no matches (and no additional surplus), and if st = k, the mechanism creates one (A; ) pair and generates surplus equal to UA . Analogous conclusions pertain to the case in which a (B; ) pair arrives. Thus, a mechanism with threshold k generates an expected total surplus equal to p2 UA + (1 = pUA + (1 UA + UB 2p(1 p) k (UA + UB ) + 2 2k + 1 p(1 p)U 2k + 1 p)2 UB + p)UB and the resulting expected total welfare for one period of time, accounting for waiting costs, is then: 12 p(1 p)U 2k(k + 1)c (2) 2k + 1 2k + 1 When the cost of waiting c is high, waiting for potentially higher-quality matches does pUA + (1 p)UB not justify any waiting and the mechanism matches agents instantaneously as they arrive. For su¢ ciently low costs, however, the optimal mechanism exhibits non-trivial waiting. The optimal threshold k opt maximizes the welfare as given in (2). The following proposition summarizes our discussion and provides the full characterization of the optimal mechanism. Proposition 2 (Optimal Thresholds). The threshold $r % p(1 p)U k opt = 2c identi…es an optimal dynamic mechanism. In this optimal mechanism, all available (A; ) and (B; ) pairs, and any number of (A; ) or (B; ) pairs exceeding k opt , are matched immediately. Furthermore, the optimal mechanism is generically unique.15 Notice that when waiting costs are prohibitively high, namely when c > maximal queue length is k opt p(1 p)U , 2 the = 0 and all matches are instantaneous. In our characterization of the optimal mechanism, we do not worry about individual rationality constraints. This is tantamount to assuming that the outside option each agent faces, or any agent’s utility from remaining unmatched, is su¢ ciently low such that the expected value of waiting as prescribed by the mechanism is greater than leaving the market unmatched. In Section 7.1 we return to this point and provide an explicit bound on the value of leaving the market unmatched that would guarantee individual rationality. 3.3 Welfare We now turn to the expected per-period welfare in a stationary state. Were we to consider no costs of waiting, the optimal mechanism would naturally entail long waits to get the maximal possible match surplus asymptotically by matching A-squares with -rounds and B-squares 15 When q p(1 p)U 2c 2 Z+ ; there are two optimal thresholds: 13 q p(1 p)U 2c and q p(1 p)U 2c 1: with -rounds. We denote the resulting welfare by: S1 pUA + (1 p)UB : The optimal threshold identi…ed in Proposition 2 allows us to characterize the welfare achieved by the optimal mechanism through equation (2) and to get the following corollary.16 Corollary 1 (Optimal Welfare). The welfare under the optimal mechanism is given by W opt (c) = S1 (c); where p(1 p)U for all c (c) is continuous, increasing, and concave in c; lim (c) = 0; and c!0 (c) = p(1 p)U : 2 As waiting costs approach 0; the welfare induced by the optimal mechanism approaches S1 : For costs large enough, the optimal mechanism matches square-round pairs instantaneously as they arrive and the resulting welfare is S1 p(1 p)U: For intermediate costs, the optimal mechanism generates welfare that is naturally in between these two values.17;18 The observation that welfare under the optimal mechanism decreases as c increases is rather intuitive. Indeed, suppose c1 > c2 : Were we to implement the optimal mechanism with waiting cost c1 when the waiting cost is c2 ; the distribution of matches would remain identical, while waiting costs would go down, thereby leading to greater welfare overall. This implies that the welfare under the optimal mechanism with waiting cost c2 ; which would be at least weakly higher, is greater than that corresponding to waiting cost c1 : The amount by which welfare decreases when waiting costs increase depends on the number of agents expected to wait in line in the steady state. The higher the waiting costs, the lower the number of agents waiting in line on average. Therefore, the impact of an increase in costs by a …xed increment is greater at smaller costs, which leads to the concavity of 16 (c). In the Appendix, we provide the analytical formula for (c) in terms of the fundamental parameters of our setting. 17 Notice that the value of S1 is e¤ectively the analogue of the value generated by an “omnsicient”planner in our setting, which is used as one benchmark in Akbarpour, Li, and Oveis Gharan (2014). The corollary suggests that the omniscient planner’s value is a valid feasible benchmark when waiting costs vanish. 18 In fact, simple algebraic manipulations imply that: p p S1 2p(1 p)U c c W opt (c) S1 2p(1 p)U c + c: 14 4 Decentralized Dynamic Matching 4.1 The Decentralized Process Many dynamic matching processes are in essence decentralized: child adoption in the US and abroad, job searches in certain industries, etc. It is therefore important to understand the implications of decentralized dynamics, particularly when considering centralized interventions. In our decentralized matching process, we assume individuals join the market in sequence and decide when to match with a potential partner immediately and when to stay in the market and wait for a potentially superior match. Formally, we assume that at each period t, there are three stages. First, a random square and round enter the market with random attributes as before: with probability p the square is an A-square and with probability p the round is an -round. Second, each square and round declare their demand –whether a square will match only with an -round, only with a -round, or any round and whether a round will match only with an A-square, only with a B-square, or with any square. In the third stage, given participants’demands, individuals are matched in order of arrival. That is, the process follows a …rst-in-…rst-out protocol.19 Any remaining participants proceed to period t + 1 (at an additional cost of c).20 As before, the market e¤ectively entails four possible queues of rounds and squares of all types and we denote by kx the length of the queue corresponding to an x type of agent, where x = A; B; ; . For simplicity, we will assume from now on a symmetric setting. That is, we assume: UA ( ) UA ( ) = U (A) U (B) and UB ( ) UB ( ) = U (A) U (B): Last, we assume that the environment is regular in that p (UA ( ) UA ( )) 6= kc and 2p(1 p) (U (A) U (B)) 6= kc for all natural numbers k 2 N: Regularity assures that neither squares nor rounds are ever 19 The assumption that matches are made in order of seniority in the market simpli…es our analysis substantially. There is some anecdotal evidence that order of arrivals in several markets a¤ects the sequence of matching. For instance, in international adoption many countries follow a …rst-in-…rst-out criterion to match abandoned children to adoptive parents. For example, see the protocol adopted by the China Center of Children’s Welfare and Adoption (CCCWA) here: http://www.aacadoption.com/programs/china-program.html. 20 The outcomes of the process we describe would be identical had we allowed participants to report no demand at a period and ruled out weakly dominated actions. 15 indi¤erent between waiting in queue and matching immediately with an available partner.21 In what follows, we will focus on trembling-hand equilibria of the process. Roughly speaking, we do so to rule out situations in which a square and a round prefer to match with one another immediately but both choose to reject one another since such mutual rejection is robust to a unilateral deviation.22 4.2 Equilibrium Characterization Given our assumptions on utilities, squares and rounds are always willing to match with rounds and A-squares, respectively, as soon as possible. Therefore, an A-square can always match with a round immediately (indeed, an equal number of squares and rounds arrive at the market and an equal number of them exit by matching, so there is always a round available). If only -rounds are available, depending on the status of the queue, an A-square may decide to wait in line for the chance of a superior match with an -round later on or to match immediately with a -round. Consequently, a -round may wait in the queue either by choice, hoping to match with a willing A-square at later periods, or by necessity, when all squares in the queue are unavailable as they refuse to match with -rounds. A similar description holds for -rounds and B-squares. 4.2.1 Agents’Decision to Wait in Line At the beginning of a period, the queue cannot entail both A-squares and -rounds, as that implies an ideal match was not formed and waiting costs have been incurred at no bene…t to some participants in the previous period. As before, we denote the (signed) length of the Aqueue at the beginning of a period by kA kA k : We …rst consider the decisions of an A-square (analogous analysis holds for an -round). When an A-square arrives at the market and an -round is available (one that had either been waiting in the queue or that has just arrived at the market as well), an A-square is matched 21 The assumption of regularity is not crucial and similar analysis follows without regularity for any arbitrary tie-breaking rule. However, the presentation is far simpler for regular environments. 22 Such behavior cannot be ruled out by simply eliminating weakly dominated strategies without further assumptions on the process. 16 immediately to an -round, the identity of whom is prescribed by the order of arrival. If the arriving A-square is the …rst to arrive in line, that square is matched to an -round. If there are A-squares already in queue, this implies that our A-square arrived with an -round and the round will be matched with the …rst A-square in the queue. In that case, the A-square has a choice of whether to wait in line or match with a -round. However, notice that this square’s decision is equivalent to the last A-square who had arrived and decided to wait. In that case, the new A-square waits and queues remain as they were. Suppose now that an -round is not available when an A-square enters the market. This implies that there is at least one -round available (that the square can match with). The square decides to wait in the queue only based on the number of A-squares in the queue. An immediate match with a -round delivers UA ( ), whereas waiting in line till matching with an -round delivers UA ( ) at an uncertain cost of waiting. It is worth noting that once an A-square decides to wait in the queue (rather than match immediately with a -round), she will wait until matching with an -round (rather than leave the queue by matching with a -round at a later point). Indeed, as matches form on a …rstin-…rst-out basis, her position in the queue moves up over time, and the expected time until matching with an -round becomes shorter. That is, if it is optimal for her to wait in the queue upon entry, it is optimal for her to wait at any later period. The expected waiting time till a match with an -round is therefore solely determined by the number of other A-squares who precede the square in the queue. The following lemma identi…es bounds on the size of the kA queue: k dec Lemma 2. In all periods, k dec kA k dec where kc < UA ( ) p kc = max k 2 Z+ j < U (A) p max k 2 Z+ j UA ( ) U (B) : Intuitively, the time till an -round enters the market is distributed geometrically (with parameter p). The expected time till an -round arrives at the market is therefore p1 : An A-square who is k-th in line in the queue will be matched when k is expected to occur within k p -rounds arrive, which periods. The expected waiting costs are therefore generate an increase in match utility of UA ( ) 17 kc ; p which UA ( ) (relative to matching with a -round immediately). An A-square will wait as long as the expected bene…t of waiting exceeds its costs, which is the comparison underlying the maximal size of the queue as described in the lemma. Our regularity assumption further guarantees that an A-square or an -round are never indi¤erent between waiting in line and matching immediately. The lemma implies that A-squares’and -rounds’behavior is essentially captured by the maximal queue length k dec . Whenever there are fewer than k dec A-squares in queue, a new A-square will wait in the market; whenever there are k dec or more A-squares in the queue, that square will prefer to match with a -round immediately. An analogous description holds for -rounds and our symmetry assumptions assure that the maximal queue length is identical for A-squares and -rounds. We now turn to the decisions of B-square and -rounds. A -round (similarly, a B-square) may decide to wait voluntarily by hoping to match with an A-square who will become available when the line for A-squares exceeds k dec . In principle, there are two forces at work. The …rst is similar to that experienced by the A-squares waiting in line: the longer the queue of -rounds waiting ahead in line, the longer the new -round has to wait. The second force, however, suggests that the longer is the queue, the closer are A-squares to reach the threshold k dec and be matched with -rounds. The next lemma illustrates that the sum of these two forces assures that B-squares and -rounds do not coexist in the market. Lemma 3. There can never be both a B-square and a -round waiting in the market. To understand the intuition of Lemma 3, consider the …rst -round arriving at the market. In this case, there cannot be other A-squares waiting in the market since any such squares would have arrived with -rounds, in contradiction to our -round being the …rst in line. Suppose that the -round arrives with a B-square. To match with an A-square, she would have to wait for the arrival of at least k dec +1 A-squares, since the …rst k dec A-squares will wait in line if not matched with -round. This implies that the cost of waiting for the -round is dec (kdec +1)c at least , which is strictly greater than the cost k p c faced by the last A-square willing p to wait in the market for her desirable match. From our super-modularity assumption, the bene…t from waiting is U (A) U (B) < U (A) U (B) = UA ( ) 18 UA ( ): Therefore, since an A-square is not willing to wait for a -round when facing a queue of k dec + 1; nor would the -round. Similar calculations follow for longer queues of -rounds (see Appendix). Given our focus on trembling-hand perfect equilibria, it follows that we can never have both -rounds and B-squares stay in the market at the same time. Lemmas 2 and 3 together imply that, in equilibrium, the decentralized process follows a protocol similar to that implemented by the optimal mechanism and depicted in Figure 1, though the thresholds governing them may be di¤erent. Indeed, whenever an A-square and an -round, or a B-square and a -round, enter the market together, a match is generated immediately (of either an (A; ) pair or a (B; ) pair, respectively) and the lengths of the queues do not change in that period. The length of the queues can increase or decrease only upon the arrival of an (A; ) pair or a (B; ) pair. As long as the queue (of either A-squares or -rounds) is strictly shorter than its maximum of k dec , the arrival of a new mismatched pair can either increase or decrease the length of the queue by precisely one. 4.2.2 Steady State of Decentralized Matching As for the optimal mechanism, the length of the A- queue kA follows a Markov process. Therefore, the transition matrix follows the description in Section 3.1. Denote by xt (xtkdec ; xtkdec 1 ; :::; xt kdec +1 ; xt kdec )tr 2 f0; 1g2k dec +1 the state of the market in period t –that is, xti is an indicator that takes the value of 1 if the queue length is precisely i and 0 otherwise. Then, xt+1 = Tkdec xt ; where Tkdec is that described in (1). Since this Markov chain is ergodic for any threshold, it is characterized by a unique stationary distribution, which is uniform across the 2k dec + 1 states. The following proposition provides the characterization of the equilibrium steady state of the decentralized process. Proposition 3 (Decentralized Steady State). There is a unique trembling-hand equilibrium under the decentralized matching process. This equilibrium is associated with a unique steady state distribution over queue lengths, such that the length of the A- queue kA = kA uniformly distributed over f k dec ; k dec + 1; : : : ; k either 19 dec k is g, and in any period, the queues contain 1. kA A-squares and -rounds, and no -rounds and B-squares, or 2. jkA j -rounds and B-squares, and no A-squares and -rounds. The threshold k dec is determined by the decisions of A-squares and -rounds to wait, as speci…ed in Lemma 2. The crucial di¤erence between the decentralized and optimal mechanism is the threshold placed on the maximal stock of A-squares or -rounds in waiting. Notice that a decision to wait in the market imposes a negative externality on succeeding agents, as it potentially a¤ects their waiting time, and possibly the quality of their matches.23 In the decentralized process, agents do not internalize this externality and therefore wait “too much”. Recall that we denoted by k opt the threshold characterizing the optimal mechanism (speci…ed in Proposition 2). We then have the following corollary: Corollary 2 (Threshold Comparison). Maximal waiting queues are longer in the decentralized process than they are under the optimal mechanism. That is, k opt k dec : As mentioned, in Section 7.1, we handle individual rationality constraints explicitly. Namely, we provide a bound on the value of leaving the market unmatched that assures our decentralized process (and, from the corollary above, also the optimal mechanism) is individually rational. 4.3 Welfare Since the protocols are similar except for the queues’ thresholds, the expected per-period welfare in the steady state characterized in Proposition 3 can be found using an analogous derivation to that carried out for the optimal mechanism. This derivation leads to an expression mirroring equation (2), accounting for the decentralized process’threshold k dec : That is, the expected per-period welfare is given by: W dec (c) = S1 p(1 p)U 2k dec + 1 23 2k dec (k dec + 1)c ; 2k dec + 1 From a welfare perspective, the externality on the quality of the match is of less importance. As long as a social planner views identical agents as interchangeable, an immediate mismatch or a later mismatch have similar welfare consequences. 20 where, from Lemma 2, k dec = p (UA ( ) UA ( )) c = p (U (A) U (B)) c : (3) To summarize, we have the following corollary: Corollary 3 (Decentralized Welfare). The welfare under the decentralized process is given by W dec (c) = S1 c p (UA ( ) (c); where lim (c) = p (UA ( ) c!0 UA ( )) ; and (c) = p(1 p)U for all UA ( )) : Recall Corollary 1, which characterized the welfare under the optimal mechanism. By de…nition, the welfare generated under the optimal mechanism is higher than that generated by the decentralized process, so that (c): In contrast with the optimal mechanism (c) that generates welfare that is decreasing in waiting costs, this is not necessarily the case under the decentralized process. Furthermore, while the welfare under the optimal mechanism approaches S1 as waiting costs diminish, this is not the case under the decentralized process. As waiting costs become very small, there is a race between two forces. For any given threshold, the overall waiting costs decline. However, in equilibrium, decentralized thresholds increase, leading to greater expected wait times. As it turns out, the balance between these two forces generates signi…cant welfare losses, given by p (UA ( ) UA ( )), even for vanishingly small costs. The next section provides a detailed comparison of the two procedures in terms of welfare. 5 Welfare Comparisons By construction, the optimal mechanism generates welfare that is at least as high as that generated by the decentralized process. In this section we inspect how the welfare wedge responds to the underlying parameters of the environment, suggesting the settings in which centralized intervention might be particularly useful. The following proposition captures the e¤ect on the welfare wedge W opt (c) W dec (c) of both waiting costs c, the frequency p of A-squares or -rounds, and the utility bene…t for an -round from matching with an A-square rather than a B-square (equivalently, the utility bene…t for an A-square from matching with an -round rather than a -round). 21 Proposition 4 (Welfare Wedge –Comparative Statics). 1 1. For any interval [c; c); where c > 0; there is a partition f[ci ; ci+1 )gM i=1 ; where c = c1 < c2 < ::: < cM = c; such that W opt (c) W dec (c) is continuous and increasing over (ci ; ci+1 ) and W opt (ci ) for all i = 1; :::; M W dec (ci ) > W opt (ci+1 ) W dec (ci+1 ) 1: 2. As c becomes vanishingly small, the welfare gap W opt (c) that is increasing in p 2 [0; 1) and in U (A) W dec (c) converges to a value U (B): To see the intuition for the comparative statics corresponding to waiting costs, notice that an increase in costs has two e¤ects on the welfare gap. Since the equilibrium threshold under the decentralized process is greater than the optimal threshold (Corollary 2), an increase in waiting costs has a direct e¤ect of magnifying the welfare gap. Nonetheless, there is also an indirect e¤ect of an increase in waiting costs that arises from the potential changes in the induced thresholds. Consider a slight increase in waiting costs such that the optimal threshold does not change, but the decentralized threshold decreases. In some sense, the decentralized process is then “closer” to the optimal process –both the matching surplus and the waiting costs are closer and the welfare gap decreases. In fact, as costs become prohibitively high, both processes lead to instantaneous matches and identical welfare levels. As we show in the proof of Proposition 4, the indirect e¤ect overwhelms the direct e¤ect at precisely such transition points and acts to shrink the welfare gap. The construction of the partition is done as follows. Each atom [ci ; ci+1 ) of the partition corresponds to constant thresholds under the decentralized process. Over these intervals, the direct e¤ect described above dominates and the welfare gap is increasing. Each of the endpoints fci gi corresponds to a decrease of the decentralized threshold by one. That is, the decentralized threshold is not constant over [ci ; ci+2 ) for all i: Therefore, when comparing two such endpoints, the indirect e¤ect kicks in and the decreasing trend of the welfare gap emerges. Figure 2 depicts the resulting pattern the welfare gap exhibits for UA ( ) = U (A) = 3; UA ( ) = U (B) = UB ( ) = U (A) = 1; UB ( ) = U (B) = 0; and p = 0:3: As suggested by the proposition, W opt (c) piece-wise increasing in c. Nevertheless, overall, the gap has a decreasing trend. 22 W dec (c) is Figure 2: Welfare Gap between Optimal and Decentralized Matching as a Function of Costs To glean some intuition on the comparative statics the welfare gap displays with respect to p, consider two type distributions governed by p1 and p2 such that p1 < p2 = mp1 ; m > 1. Suppose further that costs are so low that the match surplus in the decentralized process is very close to the optimum, S1 : The individual incentives to wait are higher under p2 than under p1 : In fact, in the decentralized setting, the distribution of steady state queue length is the uniform distribution where, from (3), under p2 ; roughly 1 1=m of the probability mass is allocated to queue lengths larger than those realized under p1 . For each of these large steady state queue lengths, we have more pairs of agents waiting, i.e., increased per-period waiting costs. The optimal mechanism internalizes the negative externalities, so the e¤ect of the increased waiting costs is weaker. On the other hand, the bene…t of this increase in queue length is a lower chance of producing mismatches. However, for su¢ ciently low c; the match surplus under p1 is already close to its optimum of S1 and this e¤ect is weak; in particular, the di¤erence in terms of match surplus that the optimal and decentralized processes generate is similar under p1 and p2 . Therefore, for su¢ ciently low c; the dominant e¤ect is the one produced by the di¤erential in expected waiting costs, which generates our comparative statics. Notice that if p = 0 or p = 1; both the optimal mechanism and the 23 decentralized processes generate the same welfare.24 Going back to our assumption of super-modular preferences, note that the construction of the optimal mechanism would remain essentially identical were preferences sub-modular (with an appropriate relabeling of market participants). However, in the decentralized setting, sub-modular preferences would lead to a negative welfare e¤ect compounding the negative externalities present in our setup. Namely, individual incentives would be misaligned with market-wide ones. In that respect, our comparison of optimal and decentralized processes assuming super-modular preferences is a rather conservative one. Similarly, considering waiting costs that di¤er across the two sides of the market, which may be reasonable for many applications, would lead to a greater welfare wedge as well. Intuitively, suppose that squares experience a waiting cost of c1 and rounds experience a waiting cost of c2 ; where c1 > c2 ; with an average cost of c = (c1 + c2 )=2: The optimal mechanism with asymmetric costs would coincide with that corresponding to identical costs of c since per-pair costs are the same in both cases: The decentralized process would also lead to an equilibrium similar to that we described, but thresholds would no longer be symmetric. Indeed, A-squares would be willing to wait when the queue of A-squares is no longer than kSdec and -rounds would be willing to wait when the queue of -rounds is no longer than kRdec ; where kSdec = p (UA ( ) UA ( )) c1 and kRdec = p (U (A) U (B)) : c2 From convexity, it follows that the threshold k dec corresponding to identical costs of c satis…es k dec (kSdec + kRdec )=2: Therefore, the excessive waiting decentralized processes exhibit would be even more pronounced when costs are asymmetric across market sides.25 6 Transfers and Fixed Matching Windows So far, we have shown that intervention in dynamic matching markets can have a substantial impact on welfare, at least when centralization is done using the optimal dynamic mechanism. However, the full-‡edged optimal mechanism may be hard to implement. It requires that the formation of matches, even those of individuals who would prefer to wait in the market, 24 25 In particular, there is a discontinuity of the welfare gap around p = 1: We provide a full characterization of this case in the Online Appendix. 24 be within the purview of the centralized planner. It also requires the central planner to monitor the market continuously to determine when matches should be formed, which may be administratively costly. In this section we show that improvements to decentralization can be achieved by mechanisms that relax each of these two requirements. We start by showing that a tax scheme imposed on those who wait in the market can yield the optimal waiting patterns, if tailored appropriately. We then analyze a simple centralized matching protocol that, while not optimal, can provide substantial welfare improvements over the decentralized matching process, and does not require the clearinghouse to monitor the market continuously. Namely, we consider matching processes in which the centralized clearinghouse matches all available agents every …xed number of periods. 6.1 Optimal Taxation Certainly, a …xed per-period tax on waiting 0 can be set so that the resulting de-facto cost of waiting, c + , is such that the decentralized process generates the optimal threshold (with costs c).26 Namely, can be set so that p (UA ( ) UA ( )) = c+ r p(1 p)U 2c : (4) In fact, if collected taxes in period t are given to new entrants in period t + 1; they would have no e¤ects on either overall welfare or individual incentives. Nonetheless, there is a risk that such a policy would introduce a strong incentive for agents to enter the market only in order to gather the previous generation’s taxes. As it turns out, there is a tax scheme that is budget balanced such that the expected tax (or subsidy) for an entering agent who is not privy to the pattern of queues in place is nil. Under such a scheme, no agent is tempted to enter the market only for the sake of reaping the bene…ts of taxes. Indeed, consider a linear tax scheme –an agent who is k-th in line pays k to the matching institution, regardless of whether they are a square or a round and regardless of their type. To achieve budget balance, the collected taxes are equally redistributed back to the existing agents in the market in each period. ^ the resulting net tax (that is added to the …xed cost c) for When the length of queue is k, 26 This is always possible from Corollary 2. 25 an agent who is k-th in line is k 2 Pk^ k=1 2k^ k = k k^ + 1 2 ! : ^ In particular, the net added tax on waiting for the last person in the queue is (k2 1) ; which ^ Thus, using the de…nition of from equation (4), we is increasing in the queue’s length k. want the tax levied on the last agents in the queue of length k opt to satisfy (k opt 2 1) = () = 2 k opt 1 : Such a taxation policy might still be di¢ cult to administer in terms of the …nancial activity it would entail. Without taxation, the optimal mechanism may be viewed as too complex for certain applications as it requires matchings that depend on the state of the market. Indeed, optimality dictates matchings that occur at points in time that are not perfectly predictable at the outset of the process and the clearinghouse needs to monitor the queues of individuals continuously. This complexity could translate to excessive administrative burdens. In the next subsection we o¤er the analysis of a simple mechanism that, while not optimal, can generate substantial welfare improvements relative to the decentralized process. 6.2 Matching with Fixed Windows We now consider the class of mechanisms that are identi…ed by a …xed-window size – every …xed number of periods, the e¢ cient matching for the participants arriving at the market in that time window is formed and the market is cleared. Larger windows then allow for thicker markets and potentially more e¢ cient matchings. However, larger windows also correspond to longer waiting times for all participants. We identify the optimal …xed window and illustrate that it can generate substantially greater welfare than that produced by the decentralized process. However, the welfare it generates is still notably lower than that produced by the optimal mechanism. The arrival of squares and rounds is the same as that analyzed so far. When …xed matching windows are used, a window size n governs the process. Namely, every n periods, the most e¢ cient matching pertaining to the n squares and n rounds who arrived within the window is implemented. 26 Suppose that kA and k are the numbers of A-squares and -rounds who arrived during a window of n time periods, respectively. Given our assumptions on match utilities, e¢ cient matchings correspond to a unique distribution of pair-types (number of (A; ) pairs, (A; ) pairs, etc.) and generate the maximal number of (A; ) and (B; ) pairs. The total matching surplus generated by a matching as such (the generated welfare not accounting for waiting costs) is k UA + (kA k )UA + (n kA )UB if kA k ; kA UA + (k kA )UB + (n k )UB otherwise. Consider now the expected waiting costs when the window size is n: The …rst square and S(kA ; k ) round to arrive wait for n 1 periods, the second square and round to arrive wait for n 2 periods, etc. Thus, the total waiting cost is 2 c ((n 1) + (n 2) + + 0) = cn(n 1): Therefore, the expected per-period welfare for each square-round pair generated by a window size n is Wn 1 X n 0 k ;k A c(n n n kA n kA pA (1 k pA )n kA k p (1 p )n k S(kA ; k ) 1): Notice that for any window size n, the matching surplus S(kA ; k ) is at most nUA ; while expected waiting costs are cn(n nUA cn(n 1): Denote by nmax the largest window size n such that 1): Every window of size n > nmax would then generate a lower welfare than that generated by a window of size 1; corresponding to instantaneously matching individuals. In particular, an optimal window size exists within the …nite set f1; 2; :::; nmax g: 6.2.1 Optimal Window Size A characterization of the precise optimal window size is di¢ cult to achieve. In what follows, we describe bounds on the optimal window size. In turn, these bounds land themselves to bounds on the maximal expected welfare generated by using …xed windows, which we can then compare to the welfare generated by the optimal mechanism as well as the decentralized process. Consider the ex-ante marginal bene…t produced by increasing the window size from n to n + 1 that is incurred by the …rst n square-round pairs who arrive at the market. Suppose that 27 an e¢ cient matching corresponding to the …rst n pairs generates at least some mismatches (i.e., (A; ) or (B; ) pairs). The (n + 1)-th pair could be bene…cial for the …rst n pairs by correcting a mismatch. If there is no mismatch among the …rst n pairs, expanding the window size only leads to additional waiting costs for the …rst n pairs. Denote the probability that any e¢ cient matching with the …rst n squares and rounds has a mismatch (i.e., there is an unequal number of A-squares and -rounds) by k j P r (jkA 1; n) : Since we assumed identical distribution of types of squares and rounds, an e¢ cient matching from n pairs has mismatches of type (A; ) or (B; ) with equal probability. A mismatch of type (A; ) is corrected by a new (n + 1)-th pair of type (B; ), which occurs with probability p(1 p), and the total bene…t for the pair of originally mismatched square and round is UA ( ) + U (B) UA ( ) U (A): A similar derivation follows for the bene…t of “correcting” a mismatched pair of type (B; ): Conditional on any e¢ cient matching entailing a mismatch, the expected bene…t to the …rst n square-round pairs is then p(1 p) 2 + p(1 p) 2 (UA ( ) + U (B) UA ( ) U (A)) (U (A) + UB ( ) U (B) UB ( )) ; which is equal to p(1 p) U : 2 Thus, the ex-ante marginal welfare from expanding the window size from n to n + 1 for each of the n …rst square-round pairs is: + Wn p(1 p) U P r (kA 6= k ; n) 2n 2c: The optimal window size no is then determined by + Wno 0 + Wno 1 : That is, it is (weakly) bene…cial to increase the window size from no bene…cial to increase the window size from no to no + 1. 28 (5) 1 to no , and it is not While it is di¢ cult to accomplish a closed-form solution for the optimal window size, the following proposition utilizes inequality (5) to establish bounds on no .27 Proposition 5 (Optimal Window Size). 1. An upper bound for the optimal window size is given by no p(1 p)U 4c : 2. For any " > 0, there exists c such that if c < c , a lower bound for the optimal window size is given by no p(1 p)U : (4 + ")c Recall that U captures the extent to which preferences exhibit super-modularity, the welfare advantage of an assortative matching relative to an anti-assortative one. Intuitively, the bounds on the optimal window size increase with U and decrease with the cost of waiting. To understand the dependence on p(1 p); let m be the number of pairs in the market of type (A; ) or (B; ): The designer’s aim is to achieve a small number of such mismatches. Clearly, when m is odd, the probability of at least one mismatch is one. Suppose m is even, m = 2l: 1 2l 2 2l l The conditional probability of having a mismatch is then 1 which is increasing in l: If we focus on large n; the probability of an even or an odd m are approximately equal. Furthermore, when p(1 p) increases, there is a greater probability of (A; ) or (B; ) pairs and the expected value of m is higher. Fixing all else, a greater p(1 p) would then intuitively lead to a lower match surplus. Thus, the optimal window size grows with p(1 p): Notice that Proposition 5 implies that the optimal window size is smaller than the threshold induced by the decentralized process, at least for su¢ ciently low costs. That is, no < k dec for low waiting costs. In particular, the bounds we identify in Section 7.1 on the value of leaving the market unmatched that guarantee individual rationality under the decentralized process, also assure individual rationality under the …xed-window mechanism. It also follows 27 The di¢ culty stems from the fact that inequality (5) depends crucially on P r (kA 6= k ; n) = 1 n X l=0 n l p (1 l 2 p)n l ; and state-of-the-art combinatorics has little to say about this function’s behavior with changes in n: 29 that the choice of the optimal window size allows for some alleviation of the excess waiting the decentralized process exhibits. Indeed, as we show in the next subsection, the welfare generated by the optimal …xed window dominates that produced by the decentralized process. 6.2.2 Welfare Bounds for Fixed Windows If the waiting cost c is small, so that the optimal window size is large, we expect to have an approximate fraction p of A-squares and -rounds, in which case per-pair surplus is close to S1 : The bounds on the optimal size of the window allow us to provide bounds on how far the match surplus is from S1 and how costly the wait is. The following proposition illustrates the resulting bounds on the welfare generated by the optimal window size. Proposition 6 (Fixed-Window Welfare). 1. A lower bound on the optimal welfare is given by r 2c W f ix (c) S1 (UA UB ) U p(1 p)U 2 + 2c: 2. For any " > 0; there exists c such that if c < c , an upper bound on the optimal welfare is given by W f ix (c) S1 + r (2 + ")c (UA U p(1 p)U + 2c: 2+" UB ) Notice that as the cost of waiting becomes very small, some of the terms in the above bounds vanish. Furthermore, the bounds converge to one another and we get: limW f ix (c) = S1 c!0 Intuitively, p(1 p(1 p)U 2 : p) re‡ects the probability of a mismatched pair entering the market. As that probability grows, welfare decreases. The value of U re‡ects the value of e¢ ciently matching individuals. Mismatches are more costly when U is higher, and so U a¤ects the expected welfare negatively as well. Proposition 6 allows us to compare the performance of the optimal …xed-window mechanism with the performance of the optimal mechanism and the decentralized process. 30 Corollaries 1 and 3 illustrate the limit values of W opt (c) and W dec (c) as costs become very small. These limits combined with Proposition 6 lead to the following corollary. Corollary 4 (Relative Performance of Fixed Window Mechanisms). W opt (c) c!0 W opt (c) lim W f ix (c) (1 p)U = : dec W (c) 2 (UA ( ) UA ( )) Notice that the right-hand side of the equality in Corollary 4 is lower than 1. Therefore, the corollary suggests that the optimal …xed-window mechanism potentially provides a substantial improvement over the decentralized process. Whenever 1 p; U > 0; the right hand side of the equality in Corollary 4 is strictly positive, which implies that the welfare generated by the optimal …xed-window mechanism is still signi…cantly lower than that generated by the optimal mechanism. As p decreases, or U increases, the welfare generated by the …xed-window mechanism provides a greater improvement over the decentralized process. 7 Conclusions and Extensions We considered a dynamic matching setting and identi…ed the optimal matching mechanism in an environment as such. The optimal mechanism always matches immediately congruent pairs and holds on to a stock of mismatched pairs up to a certain threshold. When matching follows a decentralized process, a similar matching protocol ensues in equilibrium, but the induced thresholds for waiting in the market are larger as individuals do not internalize the negative externalities they impose on those who follow. This di¤erence generates a potentially signi…cant welfare wedge between decentralized processes and centralized clearinghouses, even when waiting costs are vanishingly small. Our results provide guidance as to the features of the economy that could make centralized intervention more appealing. We also o¤er several simple interventions to decentralized markets – transfer schemes that can induce optimal outcomes, and …xed-window mechanisms, which are arguably far less complex than the full-‡edged optimal mechanism and can provide substantial welfare improvements relative to decentralization. In what follows, we discuss two channels by which our results could be expanded. First, we discuss individual rationality constraints and illustrate the class of utilities under which 31 all of the processes discussed in the paper are individually rational. Second, we describe how our techniques can be used for more general asymmetric environments. 7.1 Individual Rationality Throughout the paper we assumed that agents leave the market only after being matched. Agents do not leave the market unmatched, regardless of their expected utility. Certainly, if remaining unmatched generates zero utility, our assumption violates individual rationality as some agents (in particular, B-squares or -rounds) sometimes stay in the market simply since no other available agent will match with them. These agents could consequently earn a negative expected utility even when Ux (y) > 0 for all x; y. Assume that any agent prefers to match with any other agent immediately over remaining unmatched. We now provide a bound on the value of remaining unmatched, or the value of an outside option agents have, that assures all the matching protocols we discuss are individually rational. Notice that since, from Corollary 2, the decentralized threshold is higher than the optimal threshold, it su¢ ces to …nd such a bound that guarantees that the decentralized process is individually rational. In the decentralized process, A-squares or -rounds always have the possibility of matching with -rounds or B-squares instantaneously when they decide to wait in the market. Therefore, when deciding to wait they expect an even greater utility and individual rationality holds for them. Consider now -rounds (analogously, B-squares). A -round who enters as k-th in line can always declare all squares as acceptable in each period. Notice that, by construction, k k dec : The time between arrivals of B-squares is distributed geometrically with probability 1 p: Therefore, with such a strategy, the expected time for the -round to match with a B-square is at most k=(1 p); yielding a match utility of U (B): The wait time till match- ing with a B-square could be even shorter if -rounds who precede the -round in question are willing to match only with A-squares. Furthermore, the -round could end up matching with an A-square before k B-squares arrive at the market. It follows that such a strategy guarantees an expected utility of at least U (B) kc 1 p U (B) k dec c 1 p U (B) 32 p 1 p [U (A) U (B)] U min : If -rounds follow a di¤erent strategy in equilibrium, it must be that their utility is at least as high. Therefore, as long as the value of remaining unmatched is lower than U min , individual rationality holds under both the optimal and the decentralized processes (analogous calculations follow for B-squares and, under full symmetry of utilities, the bound corresponding to them is also U min ). In addition, since the optimal …xed-window size is smaller than the decentralized equilibrium threshold, the construction above assures that this bound on remaining unmatched assures individual rationality for the …xed-window protocol as well. 7.2 Introducing Asymmetries Our symmetry assumptions, while potentially relevant for several applications, may appear too strong for others. As it turns out, relaxing symmetry complicates somewhat the analysis, but similar techniques to those introduced in the paper can be utilized and most of our qualitative results carry through. In this section we focus on asymmetries in the distribution of types among squares and rounds. In the Online Appendix, we provide a more general analysis of the asymmetric environment, allowing for both asymmetries in payo¤s and in type distributions. Suppose, without loss of generality, that the probability of a square being an A-square is pA and that the probability of a round being an -round is p ; where pA > p : Let us …rst look at the optimal mechanism. Absent waiting costs, the optimal mechanism would entail very long waits in order to achieve the maximal feasible welfare of: S1 = p UA + (pA p )UA + (1 pA )UB : Now, consider the following mechanism for waiting costs c > 0: For each A-square that arrives at the market, the mechanism relabels the square as a B-square with probability 1 p =pA ; while all other squares and rounds maintain their original labels. The resulting market (with the altered labels) is symmetric – there are p squares labeled as A-squares and p rounds labeled as -rounds. Suppose further that the mechanism under consideration then mimics the optimal mechanism for this symmetric distribution as described in Section 3. From Corollary 1, it follows that as waiting costs diminish, the welfare from this mechanism generates welfare arbitrarily close to the maximal feasible for the symmetric distribution, i.e., a fraction close to one of the squares labeled as A-squares are matched with -rounds. This, in turn, implies that 33 the mechanism achieves welfare approaching S1 in the asymmetric market as waiting costs become very low. In particular, even in the asymmetric market, for low costs, the optimal mechanism generates welfare close to that maximally feasible, in analogy with Corollary 1. For intermediate costs, the structure of the mechanism is similar to that identi…ed in Section 1. However, the thresholds corresponding to A-squares and -rounds may be di¤erent. Intuitively, consider the case as above in which pA > p : In such a setting, the expected time between any two -rounds arriving at the market is smaller than the expected time between any two A-squares arriving at the market and so the willingness to queue by A-squares would be lower than that of -rounds. Formally, for any threshold pair (kA ; k ); there is a transition process analogous to that described in Section 3.1 through the transition matrix in (1) as follows. Denote by xt (xtkA ; xtkA 1 ; :::; xt k 1(st = i) –that is, ; xt k )tr 2 f0; 1gkA +k +1 xti is +1 the timed vector capturing the state, xti = an indicator that takes the value of 1 if the state is st (i.e., the queue length kA is st ) and 0 otherwise. Then, xt+1 = TkA ;k xt ; where TkA ;k 0 B B B B B =B B B B @ 1 (1 pA )p (1 pA )p 0 .. . 0 0 0 pA (1 p ) pA p +(1 pA )(1 (1 pA )p ::: p ) ::: ::: 0 0 0 0 0 0 .. . .. . .. . .. 0 0 0 ::: pA (1 p ) : : : pA p +(1 pA )(1 ::: (1 pA )p . 0 p ) pA (1 p ) 1 pA (1 p ) The above Markov chain is ergodic and, as in the symmetric case, an optimal mechanism corresponds to a matching process that reaches a steady state with a unique stationary distribution over states. In the Online Appendix, we derive the stationary distribution of any such process and illustrate how to determine the optimal threshold. We also show how, as waiting costs become small, a one-threshold mechanism approximates the optimal mechanism. Namely, for small costs a policy maker could consider a mechanism in which -rounds wait in the market regardless of the length of the queue of -rounds ahead of them and a cap kA is (optimally) placed on the number of A-squares who might be waiting in line. 34 1 C C C C C C; C C C A The analysis of the decentralized process is also analogous to the one described in the body of the paper and we can associate the matching process with the Markov process governed by TkA ;k as above, though with thresholds that are determined in equilibrium. As waiting costs diminish, the distance between the resulting welfare and the maximal feasible S1 is bounded below by p (UA ( ) UA ( )); which mirrors the result of Corollary 3 for the symmetric setting. In particular, the wedge between the welfare generated by the optimal mechanism and the decentralized process can be substantial even when waiting costs are minuscule. 8 Appendix 8.1 Proofs Regarding the Optimal Mechanism Proof of Proposition 1: By Lemma 1, under the optimal mechanism, at any point in time, either only A-squares and -rounds, or only B-squares and -rounds are waiting in the market. Consider a queue that contains only A-squares and -rounds, and consider a scenario in which an (A; ) pair enters the market (if any other pair enters the market, matches should be immediately implemented). The expected welfare at this time period is uniquely determined by the number of (A; ) pairs created and the number remaining agents waiting in line until the next period. From the stationarity of the process, and since waiting costs are linear, if it is optimal to retain k (A; ) pairs in the market at some period, it is also optimal to retain any k 0 k such pairs at any other periods. Let kA be the largest number of (A; ) pairs that might be allowed to wait in line. Such a number clearly exists as the optimal mechanism cannot allow an inde…nite number of (A; ) pairs to wait in line for one more period. The value of kA corresponds to the threshold that the optimal mechanism uses: i.e., whenever the queue of A-squares (or -rounds) gets longer than kA , the mechanism creates (A; ) matches such that exactly kA number of A-squares (or -rounds) wait for one more period. Similar arguments follow for queues composed of (B; ) pairs. Proof of Proposition 2: De…ne the marginal increase of welfare when increasing the threshold by one as: M W (k) W (k + 1) 2 p(1 p)U 2c(k + 1)2 W (k) = : (2k + 1)(2k + 3) 35 For a non-trivial (i.e., non-zero) optimal threshold, it is necessary that M W (0) > 0, or equivalently c < p(1 p)U : 2 Suppose c is small enough so that this is the case. Ignoring the integer constraint on k, d2 W (k) 1 = 2 dk (2k + 1)3 2c p(1 p) < 0 as 2p(1 4U p)U > c: Thus, accounting for the optimal threshold being an integer, there exists either a unique optimal threshold or two adjacent optimal thresholds. An optimal threshold k opt satis…es either M W (k opt M W (k opt 1) > 0 and M W (k opt ) 0; or 1) 0 and M W (k opt ) < 0: We rewrite the two conditions as q p(1 p)U q 2c 1 p(1 p)U 2c k opt 1 < k opt and the Proposition’s claim follows. < q q p(1 p)U ; 2c or p(1 p)U ; 2c Proof of Corollary 1: Using the optimal thresholds from Proposition 2, we get that for c p(1 p)U ; 2 v(c) w(c) We can then de…ne p(1 p)U = 2k opt + 1 2 p(1 q p)U p(1 p)U 2c ; and +1 (2k opt + 1)c c 2k opt (k opt + 1) c = = opt opt 2 2k + 1 2(2k + 1) 2 3 $r % ! 6 7 p(1 p)U 1 1 7 c: = 6 + q 4 5 2c 2 p(1 p)U 4 + 2 2c (c) = v(c) + w(c) to get the representation of W opt (c) in the corollary. 36 p(1 p)U for which 2 0 opt 28 Take any c < jc c0 j < , k opt (c ) = k (c). k opt 2 = Z+ . There exists " > 0 such that for every c0 with Thus, W opt is di¤erentiable at c. Moreover, for any c < p(1 p)U 2 such that k opt 2 Z+ , W opt (c) is semi-di¤erentiable. Hence, W opt (c) is continuous. At any di¤erentiable point c (around which k opt (c) is constant) dW opt @W (k opt (c); c) = = dc @c 2k opt (k opt + 1) < 0: 2k opt + 1 Furthermore, convexity of W opt (c) follows from the fact that at any semi-di¤erentiable but not di¤erentiable point c, 8.2 d W opt d+ W opt < : dc dc Proofs Regarding Decentralized Processes Proof of Lemma 2: The time till an -round appears in the market is distributed geometrically, and so the expected time for arrival of any -round is given by p1 : Consider an A-square who enters the market as the k-th in line when only -rounds are available. The A-square will wait in the queue if and only if kc < UA ( ) p UA ( ): From regularity, the A-square is never indi¤erent between waiting in queue and matching immediately, and the lemma’s conclusion follows. Analogous analysis holds for -rounds. Proof of Lemma 3: Consider the …rst moment the market contains at least one -round and at least one Bsquare and suppose the queue of -rounds is of length k: We show that at least one -round is willing to match with a B-square immediately. Toward a contradiction, suppose this is not the case. Since A-squares and -rounds cannot be waiting in the market simultaneously, and not all squares are A-squares (as there is at least one B-square available), it follows that kA < k: Notice that if a -round is not willing to match with a B-square at a certain period, she will not be willing to match with a B-square in future periods as well. Thus, for the 28 We slightly abuse our notation and make the dependence of k opt on the cost c explicit here. 37 last -round in queue to match with an A-square, all preceding k to match with A-squares …rst. From Lemma 2, at least k dec of A-squares would therefore be necessary for the last A-square. Hence, the expected waiting cost for that 1 -rounds would need k dec + 1 arrivals kA + k -round in queue to match with an -round is at least (kdec +1)c : p However, by super-modularity, the marginal bene…t for the -round from matching with an A-square instead of a B-square, U (A) U (B); is lower than U (A) U (B). Since an -round is not willing to wait to match with an A-square when faced with a queue longer than k dec , the last -round in queue would prefer not to wait either, in contradiction. Similar arguments follow for the B-squares in the market. Therefore, in any tremblinghand equilibrium, there cannot be both B-squares and -rounds waiting in the market. Proof of Proposition 3: First, the (signed) length of the A- queue, denoted by kA constitutes an ergodic Markov chain. Following previous arguments, the unique steady state distribution of kA is the uniform distribution over f k dec ; k dec + 1; : : : ; k dec g. At any time t, suppose that kA > 0. Clearly, the queue has no -rounds. As equal numbers of squares and rounds enter and exit the market, it must be that kA + kB = k : Lemma 3 guarantees that kB = 0; therefore k = kA . Similarly for kA Proof of Corollary 2: Whenever c > agents immediately and k opt = 0 and k opt p(1 p)U ; 2 dec k 0: the optimal mechanism matches arriving : Suppose, then, that c < p(1 2p)U : We then have r p(1 p)U pU p(1 p)U < 2c 2c 2c p(UA ( ) UA ( )) c : and the result follows from the de…nition of k opt and k dec : 8.3 Proof Regarding Welfare Comparisons Proof of Proposition 4: 1. As in the proof of Corollary 1, W opt (c) W dec (c) is di¤erentiable at any c < p(1 p)U 2 such that k opt ; k dec 2 = Z+ . In a small neighborhood around any such c, the thresholds corresponding to both the optimal and decentralized thresholds are constant in c. Therefore, d(W opt (c) W dec (c)) = dc 2k opt (k opt + 1) 2k dec (k dec + 1) + 2k opt + 1 2k dec + 1 38 0; where the inequality follows from Corollary 2, which implies that k dec k opt . Furthermore, the proof of Corollary 1 implies that W opt (c) is continuous in c and so W opt (c) W dec (c) is increasing in any point c for which k dec 2 = Z+ : Denote by: p (UA ( ) k dec (c) UA ( )) and k opt (c) c $r p(1 p)U 2c % ; essentially explicitly expressing the dependence of both the decentralized and optimal thresholds on the waiting costs, respectively. Let fdk g1 k=1 denote the decreasing sequence of costs such that k = p(UA ( ) UA ( )) : dk That is, cost dk corresponds to a threshold of k in the decentralized setting. For an arbitrary m; we will show that W opt (dm+1 ) W dec (dm+1 ) > W opt (dm ) W dec (dm ); W opt (dm+1 ) W opt (dm ) > W dec (dm+1 ) W dec (dm ): or equivalently that (6a) We …rst focus on W opt (c): When k opt (c) > 0; k opt (c) 2 Z+ ; both k opt (c) and k opt (c) 1 generate the same welfare when waiting costs are c under the optimal mechanism (so, in particular, what follows holds even if dm is a transition point corresponding to the thresholds under the optimal mechanism). Note that W opt (c) is piece-wise linear and continuous. It follows that: W q Let k 0 opt (dm+1 ) W opt Z (dm ) dm dm+1 p(1 p)U 2dm 2k opt (c)(k opt (c) + 1) dc: 2k opt (c) + 1 . For any c 2 [dm+1 ; dm ], k opt (c) 2k opt (c)(k opt (c) + 1) 1 = opt 2 2k (c) + 1 (2k opt (c) + 1) opt Z k 0 and 1 opt 2k (c) + 1 2k 0 (k 0 + 1) 2k 0 + 1 Thus, W (dm+1 ) W opt (dm ) dm 2k 0 (k 0 + 1) 2k 0 (k 0 + 1) dc = (dm 2k 0 + 1 2k 0 + 1 dm+1 0 0 2k (k + 1) 1 p(UA ( ) UA ( )) 0 2k + 1 m 0 0 2k (k + 1) p(UA ( ) UA ( )) = : 2k 0 + 1 m(m + 1) = 39 dm+1 ) 1 m+1 Next, we consider W dec (c). Denote by W (k; c) S1 p(1 p)U 2k + 1 2k(k + 1)c : 2k + 1 Note that W dec (dm+1 ) W dec (dm ) = W (m + 1; dm+1 ) = W (m + 1; dm+1 ) W (m; dm ) W (m + 1; dm ) + W (m + 1; dm ) W (m; dm ): We use the following two results: 2(m + 1)(m + 2) (dm dm+1 ) 2m + 3 2(m + 1)(m + 2) p(UA ( ) UA ( )) = 2m + 3 m(m + 1) 2(m + 2)p(UA ( ) UA ( )) = ; m(2m + 3) W (m + 1; dm+1 ) W (m + 1; dm ) = and W (m + 1; dm ) 2m(m + 1)dm p(1 p)U 2(m + 1)(m + 2)dm p(1 p)U + 2m + 1 2m + 1 2m + 3 2m + 3 2 2p(1 p)U 4(m + 1) dm = (2m + 1)(2m + 3) 1 4(m + 1)2 p(UA ( ) UA ( )) = 2p(1 p)U : (2m + 1)(2m + 3) m W (m; dm ) = Then, W dec (dm+1 ) W dec (dm ) = 2(m+2)p(UA ( ) UA ( )) m(2m+3) + 2p(1 p)U (2m+1)(2m+3) 4(m+1)2 p(UA ( ) UA ( )) : m(2m+1)(2m+3) We want to prove that (6a) holds. It su¢ ces to show that 2k 0 (k 0 + 1) 2m + 3 2m (1 p)U > 2(m + 2) + 0 2k + 1 m + 1 2m + 1 UA ( ) UA ( ) 2m (1 p)U 2m = + : 2m + 1 2m + 1 UA ( ) UA ( ) To prove the above inequality, we consider the following two cases: 40 4(m + 1)2 2m + 1 (7) Case 1: k 0 2. Note that U UA ( ) < UA ( ) (UA ( ) UA ( )) + (U (A) UA ( ) UA ( ) U (B)) = 2: (8) Since the left hand side of (7) is increasing in k 0 ; for (7) to hold, it su¢ ces that 2m 4m 6m 12 2m + 3 > + = ; 5 m+1 2m + 1 2m + 1 2m + 1 which holds for all m: Case 2: k 0 = 1. One su¢ cient condition for (7) using (8) is 4(2m + 3) 6m > ; 3(m + 1) 2m + 1 which holds for m = 1; 2; or 3. Since k 0 = 1; (1 p)U m p(1 p)U = < 4: 2dm 2(UA ( ) UA ( )) Thus, another su¢ cient condition for (7) in this case is 4(2m + 3) 2m + 16 > ; 3(m + 1) 2m + 1 which holds for every m 4. To construct the partition in the proposition, let m = max fi j di cg and m = minfi j di < cg: Now de…ne c1 = c; cM = c: If m = m; set M = 2 and the partition has only one atom. Otherwise, if m < m; set ci = dm i+1 for i = 2; :::; m m + 1 and M = m m + 2: 2. Notice that lim W opt (c) c!0 W dec (c) = lim (c) c!0 lim (c) = p (UA ( ) c!0 In particular, as c becomes vanishingly small, W opt (c) is increasing in both p and UA ( ) UA ( ), as needed. 41 UA ( )) : W dec (c) converges to a value that 8.4 Proofs Regarding Fixed Matching Windows Proof of Proposition 5: 1. Notice that + Wn = p(1 As the upper bound of p) U P r(kA 6= k ; n) 2n + Wn p(1 2c p)U 2n 2c: decreases in n, let x be the unique solution of p(1 p)U 2x 2c = 0: It follows that no 2. We …nd an upper bound of x= + Wn p(1 p)U 4c : that will provide us with a lower bound on the optimal window size. Fix a window size n, and de…ne a multinomial random variable Xt for each time t = 1; 2; : : : ; n such that 8 < 1 if (A; ) arrives, 1 if (B; ) arrives, Xt = : 0 otherwise. Thus, Xt takes the values of 1; 1; or 0 with probabilities p(1 respectively. Notice that kA k = n X p), (1 p)p, or 1 2p(1 p), Xt : t=1 Let (:) be the cumulative distribution function of the standard normal distribution. We use the Berry-Esseen Theorem on the speed of convergence in the Central Limit Theorem (see Feller, 1972 and Tyurin, 2010). Theorem 1. (Berry-Esseen) Let Y1 ; Y2 ; : : : ; Yn be i.i.d random variables with mean 0 and vari^ n the cumulative distribution function of pnZn = . ance 2 , Zn = 1 (Y1 + Y2 + ::: + Yn ) ; and G n Then ^ n (y) sup G (y) y E[jY1 j3 ] p : 2 3 n Now, notice that Var[X1 ] = E[jX1 j3 ] = 2p(1 42 p): Let F^n be the empirical cumulative distribution function of pkA k : 2np(1 p) By the Berry-Esseen Theorem, p P r(kA = k ; n) = F^n 1= 2np(1 p) p (1= 2np(1 p)) 1 p 2 np(1 Thus, p(1 + Wn p(1 = p)U 2n 1 p)U 2n 1 F^n (0) 1 (0) + p 2np(1 1 +p : p) 2np(1 p) 1 1 1 p +p p 2 2 np(1 ! p 2 +1 p 2c: 2 np(1 p) p) p) ! 2c (9) We now show that there exists c1 > 0 such that for all c < c1 ; the optimal …xed size no > 2 by illustrating that + W1 + W1 = > 0 and p(1 p)U 2 + W2 > 0. Indeed, P r(kA 6= k ; 1) 2c = p2 (1 P r(kA 6= k ; 2) 2c p)2 U 2c > 0; and + W2 = = p(1 p)U 2 p(1 p)U 4 p(1 p)U 4 = whenever c < c1 1 p2 (1 p2 + (1 p2 (1 p)2 U 2 p)2 ) (1 p3 (1 p)2 p)3 U 2 2 2p2 (1 p3 (1 2c p)2 p)3 U 2 3p2 (1 2c 2c p)2 U 8 3p2 (1 p)2 U : 16 We now consider n 3: From (9), h(r) p(1 + Wn p)U r2 2 h(r); where r = n 1=2 and ! p ( 2 + 1)r p 1 2c: 2 p(1 p) We use the following observations, assuming that c < c2 43 4 p2 (1 p)2 U p 27( 2 +1)2 < c1 : 2c > 0 1. + W3 p h 1= 3 = p(1 p)U 6 p 1 2 2 +1 3 p(1 p) p p 2c: In order to show that h(1= 3) > 0; we show that 4 p2 (1 p)2 U p(1 p)U p c< < 12 27( 2 + 1)2 1 Indeed, the right inequality holds whenever 1 p < 2 12 27( 2 + 1) ! p 2 +1 p : 2 3 p(1 p) p 2 +1 p ; 24 3 which holds if and only if p 2 +1 12 p + p = 0:4437422::: < 1: 27( 2 + 1)2 2 3 0 2. h (r) = 0 at r = 0 and 3. h(0) < 0 and h p p(1 p) p . 3( 2 +1) 4 p p(1 p) p 3( 2 +1) 4 = 8 p2 (1 p)2 U p 27( 2 +1)2 2c > 0. 4. From points 2 and 3 it follows that there exists a unique r > 0 such that h(r ) = 0 and h0 (r ) > 0. 5. For any " > 0; there exists c3 such that for any c < c3 we have h order to show this, note that s ! (4 + ") c " h = 2+ c 1 p(1 p)U 2 q (4+")c p(1 p)U ! p p ( 2 + 1) (4 + ") c p 2 U p(1 p) > 0: In 2c and the claim holds for c3 = 1 4 4+" 2 !2 p 2 U p(1 p) p p : ( 2 + 1) (4 + ") 6. From points 4 and 5, it follows that for c < min fc2 ; c3 g, r < q no q (4+")c : p(1 p)U To summarize, for any c < c minfc2 ; c3 g; for every window size n such that p1n p p (4+")c o , we have h(1= n) > 0. On the other hand, 0 W h(1= no ). Therefore, + n p(1 p)U p(1 p)U . (4+")c 44 Proof of Proposition 6: Recall that we denote by Sn the ex-ante per-pair surplus when the window size is n. We …nd bounds on Sn starting from the following inequalities: Sn Sn kA k ; g n n kA k E maxf ; g n n E minf kA k ; g n n kA k E maxf ; g n n UA + 1 E minf UA + 1 and UB UB : Notice that E min kA k ; n n = E [jkA + k ] p = p = p = p 1 2 s k j] E [jkA 2n E (kA k )2 n2 1 2 =p s (E [jkA k j])2 n2 (Jensen’s inequality) r 1 E [kA2 ] + E [k 2 ] 2s n2 2E [kA k ] 1 p(1 p) 2 p2 + 2 n r p(1 p) : 2n 2p2 (since E[kA2 ] = V (kA ) + (E[kA ])2 ) Similarly, we obtain E max kA k ; n n Therefore, for every window size n, r p(1 p) S1 (UA UB ) 2n p+ Sn r S1 + p(1 p) : 2n r p(1 p) (UA 2n UB ) : The per-pair welfare from a window size n is determined by: Wn Sn 2c(n 1): The optimal ex-ante per-pair welfare from a static matching with a …xed-window size is de…ned as Wo Sno 2c(no We now turn to the parts of the proposition. 45 1): p(1 p)U : 4c 1. From part 1 of Proposition 5, no Wn Sn 2c(n 1) S1 r Therefore, p(1 p) (UA 2n UB ) 2c(n 1): We can verify that the lower bound decreases in n by di¤erentiating the right hand side of the last inequality (ignoring integer constraints). Thus, r 2c f ix W (c) = Wno S1 (UA UB ) + 2c U p(1 p)U c 2 : 2. From the above inequalities, W f ix (c) S1 + r p(1 p) (UA 2no UB ) 2c(no 1): From part 2 of Proposition 5, for any " > 0; there exists c such that when c < c p2 (1 4 p)2 U p ; 27( 2 +1)2 no p(1 p)U : (4+2")c W f ix Therefore, (c) S1 + r 2c (UA U UB ) p(1 p)U + 2c: 2+" References [1] Akbarpour, Mohammad, Shengwu Li, and Shayan Oveis Gharan. 2014. “Dynamic Matching Market Design,”mimeo. [2] Anderson, Ross, Itai Ashlagi, David Gamarnik, and Yash Kanoria. 2014. “A Dynamic Model of Barter Exchange,”mimeo. [3] Ashlagi, Itai, Patrick Jaillet, and Vahideh H. Manshadi. 2013. “Kidney Exchange in Dynamic Sparse Heterogenous Pools,”mimeo. 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