Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Bayesian implementation

Leandro Gorno

December 2, 2014

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Bayesian Nash equilibrium

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Bayesian Nash equilibrium

Definition
The (type-contingent) strategy profile s ∗ ∈ S Θ is a Bayesian
Nash equilibrium (henceforth BNE) of the mechanism
Γ = (S1 , ..., SI , g ) if

s ∗ (θi ) ∈ arg max E{ui (g (si , s−i

∗
(θ−i )), θi )|θi }
si ∈Si

for every type θi ∈ Θi of every agent i = 1, ..., I .

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Example 1: first-price auction

Bidder’s valuations are independent and uniformily

distributed: Θi = [0, 1] for all i and the prior pdf is
φ(θ) = 1 for all θ ∈ Θ.
Given a bidding strategy profile b = (b1 , ..., bI ), the
expected payoff of bidder i is given by
 
Pr bi (θ) ≥ max bj (θj ) (θi − bi (θi )).
j6=i

How can we obtain a BNE?

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Example 1: first-price auction (cont’d)

Suppose (b1∗ , ..., bI∗ ) is a BNE of the first price-auction.
We can show that the bidding functions are monotonic.
The equilibrium payoff of bidder i with valuation θi is:
n I −1 o
Ui∗ (θi ) = max (θ̃i ) (θi − bi∗ (θ̃i )) = θi I −1 (θi − bi∗ (θi )).
θ̃i ∈[0,1]

But the envelope theorem yields:

(θi )I
Z θi
∗ ∗ I −1
Ui (θi ) = Ui (0) + (θ̃i ) d θ̃i = .
0 I
Thus,  
I −1
bi∗ (θi ) = θi .
I
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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Example 2: second-price auction

Same setting as in Example 1.

Suppose b ∗ is a symmetric and monotonic BNE. Now the
expected payoff of bidder i is given by
Z θ̃i
I −1
(θi − bi∗ (x−i ))d(x−i ).
0

Leibniz rule yields the FOC:

(θi − bi∗ (θ̃i ))(I − 1)θ̃iI −2 = 0.

Thus, the best-response of i is to set θ̃i so that bi∗ (θ̃i ) = θi .

In equilibrium, we must have θ̃i = θi , so bi∗ (θi ) = θi .
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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Bayesian implementation

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Two definitions

Definition
A social choice function is implementable in BNE if there exists a
mechanism Γ = (S1 , ..., SI , g ) with a BNE s ∗ ∈ S Θ such that
f (θ) = g (s ∗ (θ)) for all θ ∈ Θ.

Definition
A social choice function is Bayesian incentive compatible if
truthtelling is a BNE of the associated direct revelation
mechanism.

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A revelation principle for BNE

Theorem
A social choice function is implementable in BNE if and only if it
is Bayesian incentive compatible.

Proof.
Sufficiency of Bayesian incentive compatibility is obvious.
Suppose f is implementable in BNE using Γ = (S1 , ..., SI , g ).
Then, almost as in the dominant strategies case, we have

E{ui (f (θi , θ−i ), θi )|θi } = E{ui (g (si∗ (θi ), s−i

∗
(θ−i )), θi )|θi }
∗ ∗
≥ E{ui (g (si (θ̃i ), s−i (θ−i )), θi )|θi }
= E{ui (f (θ̃i , θ−i ), θi )|θi }

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Relation with dominant strategy implementation

Every dominant strategy equilibrium is also a BNE.

Thus, the revelation principle for BNE relates a weaker
assumption with a weaker conclusion.

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Expected externality mechanism

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Quasilinear environments

Recall that:

ui (x, θi ) = vi (k, θi ) + mi + ti .

Fully ex-post efficient social choice functions are hard to

implement in dominant strategies.
Can we attain full efficiency using Bayesian implementation?

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Independence assumption

Statistically independent types:

φ(θ) = φ1 (θ1 ) × ... × ...φI (θI ).

Notation: Y
φ−i (θ−i ) = φj (θj ).
j6=i

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Mechanism specification

Direct revelation mechanism (k ∗ , t1 , ..., tI ).

Efficient project choice:
I
X I
X
vi (k ∗ (θ), θi ) ≥ vi (k, θi ) (1)
i=1 i=1

Transfers:
Z X
ti (θ) = vj (k ∗ (θi , θ̃−i ), θ̃j )φ−i (θ̃−i )d θ̃−i + hi (θ−i ) (2)
j6=i

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Implementability result

Theorem
Consider the quasilinear environment and assume that types are
independent. Then, every social choice function satisfying
Equations 1 and 2 is Bayesian incentive-compatible.

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Implementability result

Proof.
( I )
X
∗ ∗
E {vi (k (θ), θi ) + ti (θ)|θi } = E vj (k (θ), θj ) + hi (θ−i )
j=1

( I )
X
≥E vj (k ∗ (θi0 , θ−i ), θj ) + hi (θ−i )
j=1

= E {vi (k ∗ (θi0 , θ−i ), θi ) + ti (θ)|θi }

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Balancing the budget

Choose  X
1
hi (θ−i ) = − ξj (θj ),
I −1 j6=i

where
Z X
ξi (θi ) = vj (k ∗ (θi , θ̃−i ), θ̃j )φ−i (θ̃−i )d θ̃−i .
j6=i

Clearly, ξi (θi ) + hi (θ−i ) = ti (θ).

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Balancing the budget

Note that
PI 1

PI P
i=1 hi (θ−i ) = − I −1 j6=i ξj (θj )
1

Pi=1
I
= − I −1 i=1 (I − 1)ξi (θi )
PI
= − i=1 ξi (θi ).

Hence,
I
X I
X I
X
ti (θ) = ξi (θi ) + hi (θ−i ) = 0
i=1 i=1 i=1

This means that the expected externality mechanism is

ex-post efficient!
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Robustness of the positive result

This implementability result is “even more” true without

statistical independence.
In fact, correlation typically allows implementation of all
social choice functions with a balanced budget, while
independence makes ex-post efficiency a matter of necessity.
Even a small amount of correlation is enough for this, but
transfers might get really large, rendering the risk-neutrality
assumption unpalatable.
See Fudenberg and Tirole (1991) and d’Aspremont et al
(2003) for more on these points.

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Linear utility

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Other mechanisms?

We might want to get a different utility distribution.

For instance, the expected externality mechanism might not
satisfy participation constraints.
So, we still want to know all Bayesian incentive compatible
social choice functions.
We will do this in the particular case of linear utility:

ui (x, θi ) = θi vi (k) + mi + ti

and statistically independent types.

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Definitions

For every i = 1, ..., I and θi ∈ Θi , define

Z
v i (θi ) = vi (k(θi , θ̃−i ))φ−i (θ̃−i )d θ̃−i ,
Z
t i (θi ) = ti (θi , θ̃−i )φ−i (θ̃−i )d θ̃−i

and
Ui (θi ) = θi v i (θi ) + t i (θi ).

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Full characterization
Theorem
The social choice function f (·) = (k(·), t1 (·), ..., tI (·)) is Bayesian
incentive compatible if and only if, for every i = 1, ..., I ,
v i (·) is non-decreasing.
Rθ
Ui (θi ) = Ui (θi ) + θ i v i (s)ds for all θi ∈ Θi .
i

Proof.
For necessity, pick θi0 > θi . Incentive compatibility implies

Ui (θi ) ≥ θi v i (θi0 ) + t i (θi0 ) = Ui (θi0 ) + (θi − θi0 )v i (θi0 )

Ui (θi0 ) ≥ θi0 v i (θi ) + t i (θi ) = Ui (θi ) + (θi0 − θi )v i (θi )

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Linear utility

Proof.
Combining the two inequalities:

Ui (θi0 ) − Ui (θi )
v i (θi ) ≥ ≥ v i (θi0 ).
θi0 − θi

Hence, v i (·) is non-decreasing. Moreover, this implies that

Ui (·) is differentiable with

Ui0 (θi ) = v i (θi ).

Integrating, we get the desired expression for Ui (θi ).

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Bayesian Nash equilibrium Bayesian implementation Expected externality mechanism Linear utility

Linear utility
Proof.
For sufficiency, suppose i is of type θi and consider her
incentives to claim a different type θi0 . Without loss, assume
θi > θi0 . Then,
Z θi Z θi
Ui (θi )−Ui (θi0 ) = v i (s)ds ≥ v i (θi0 )ds = (θi −θi0 )v i (θi0 )
θi0 θi0

Z θi Z θi
Ui (θi )−Ui (θi0 ) = v i (s)ds ≤ v i (θi )ds = (θi −θi0 )v i (θi )
θi0 θi0

These inequalities yield Bayesian incentive compatibility.

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