In** game theory and economics, a mechanism is called incentive-compatible (IC) **** if every participant can achieve their own best outcome by reporting their true **preferences. For example, there is incentive compatibility if high-risk clients are better off in identifying themselves as high-risk to insurance firms, who only sell discounted insurance to high-risk clients. Likewise, they would be worse off if they pretend to be low-risk. Low-risk clients who pretend to be high-risk would also be worse off. The concept is attributed to the Russian-born American economist Leonid Hurwicz.

Typology

There are several different degrees of incentive-compatibility: Every DSIC mechanism is also BNIC, but a BNIC mechanism may exist even if no DSIC mechanism exists. Typical examples of DSIC mechanisms are second-price auctions and a simple majority vote between two choices. Typical examples of non-DSIC mechanisms are ranked voting with three or more alternatives (by the Gibbard–Satterthwaite theorem) or first-price auctions.

In randomized mechanisms

A randomized mechanism is a probability-distribution on deterministic mechanisms. There are two ways to define incentive-compatibility of randomized mechanisms:

Revelation principles

The revelation principle comes in two variants corresponding to the two flavors of incentive-compatibility: