We introduce and solve a new class of "downward-recursive" static portfolio choice problems. An individual simultaneously chooses among ranked stochastic options, and each choice is costly. In the motivational application, just one may be exercised from those that succeed. This often emerges in practice, such as when a student applies to many colleges or when a firm simultaneously tries several technologies. Copyright The Econometric Society 2006.
We develop a decentralized Bayesian model of college admissions with two ranked colleges, heterogeneous students and two realistic match frictions: students find it costly to apply to college, and college evaluations of their applications are uncertain. Students thus face a portfolio choice problem in their application decision, while colleges choose admissions standards that act like market-clearing prices. Enrollment at each college is affected by the standards at the other college through student portfolio reallocation. In equilibrium, student-college sorting may fail: weaker students sometimes apply more aggressively, and the weaker college might impose higher standards. Applying our framework, we analyze affirmative action, showing how it induces minority applicants to construct their application portfolios as if they were majority students of higher caliber. * Earlier versions were called "The College Admissions Problem with Uncertainty" and "A Supply and Demand Model of the College Admissions Problem". We would like to thank Philipp Kircher (Co-Editor) and three anonymous referees for their helpful comments and suggestions. Greg Lewis and Lones Smith are grateful for the financial support of the National Science Foundation. We have benefited from seminars at BU,
Toward understanding assortative matching, this is a self-contained introduction to research on search and matching. We first explore the nontransferable and perfectly transferable utility matching paradigms, and then a unifying imperfectly transferable utility matching model. Motivated by some unrealistic predictions of frictionless matching, we flesh out the foundational economics of search theory. We then revisit the original matching paradigms with search frictions. We finally allow informational frictions that often arise, such as in college-student sorting. (JEL C78, D82, D83, I23, J12)
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