Pricing Under Noisy Signaling

Abstract

We provide rationale, conditions, and insights for "customized" pricing in markets, that is, for equilibria where different buyers pay different prices for similar products. We use a Spence/Riley signaling model enhanced by a signaling methodology under random relations between costs and attributes, developed by Feldman (2004) and Feldman and Winer (2004). Examples include markets for new cars, retail, human capital, trades where transaction costs are negotiable, and transactions where sellers affect buyers’ costs by offering different levels of service or support for the same products and prices. These encompass a large fraction of all assets, prices, and transactions. Our results help explain the different levels of segmentation and product/service differentiation that we observe in markets and the efficiency of these equilibria. We note that we can demonstrate the results within competitive sellers’ markets. Financial markets examples include dividend, IPO, market microstructure and capital structure signaling, and share class distinctions in mutual funds.