TITLE:
The Ambivalent Role of Idiosyncratic Risk in Asymmetric Tournaments
AUTHORS:
Kerstin Pull, Hendrik Bäker, Agnes Bäker
KEYWORDS:
Tournaments; Contestant Heterogeneity; Idiosyncratic Risk
JOURNAL NAME:
Theoretical Economics Letters,
Vol.3 No.3A,
June
18,
2013
ABSTRACT:
In our paper, we analyze the interplay of
contestant heterogeneity and idiosyncratic risk in rank-order tournaments:
While in symmetric tournaments an increase in idiosyncratic risk reduces
incentives, in asymmetric tournaments this is not necessarily the case: Rather,
we show that increasing the level of idiosyncratic risk in asymmetric
tournaments will at first increase and—only after a critical risk level has
been reached—reduce incentives. We find this critical risk level to
be higher, the larger the degree of contestant heterogeneity. Concerning
practical implications, it is more important to reduce idiosyncratic risk in
the tournament when contestants are similar and less beneficial when
contestants are heterogeneous. In light of the fact that equilibrium effort
levels in tournaments with a low level of contestant heterogeneity are by far
higher than those in tournaments with high levels of contestant heterogeneity,
the advice would be to simultaneously reduce contestant heterogeneity (e.g., by
league-building or handicapping) and idiosyncratic risk.