Bargaining under liquidity constraints: Experimental evidence

Abstract

Bargaining is widely used in monetary, labor and finance models to determine terms of trade. The chosen bargaining solution can matter for welfare analysis, for example when agents are liquidity constrained. Here we report on an experiment in which buyers and sellers engage in semi-structured bargaining to determine the terms of trade with the aim of evaluating the empirical relevance of two bargaining solutions, the generalized Nash bargaining solution and Kalai's proportional bargaining solution. These bargaining solutions predict different outcomes when buyers are constrained in their money holdings. We first use the case when the buyer is not liquidity constrained to estimate the bargaining power parameter, which we find to be equal to 1/2. Then, imposing liquidity constraints on buyers, we find strong evidence in support of the Kalai proportional solution. Our findings have policy implications, e.g., for the welfare cost of inflation in search-theoretic models of money.