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  5. Markets with Adverse Selection
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Markets with Adverse Selection

Paper Session

Friday, Jan. 5, 2024 10:15 AM - 12:15 PM (CST)

Grand Hyatt, Travis B
Hosted By: Econometric Society
  • Chair: Weijie Zhong, Stanford University

Moldy Lemons and Market Shutdowns

Jin-Wook B. Chang
,
Federal Reserve Board
Matthew Darst
,
Federal Reserve Board

Abstract

This paper studies conditions under which small changes in fundamentals cause competitive markets to shutdown due to adverse selection in a non-exclusive contracting environment. We first show that markets with non-exclusive competition are generally robust to small changes in the risk profile of agents (moldy lemons), which stands in stark contrast to exclusive contracting environments where trade may suddenly cease. We extend the environment to include outside options and establish a necessary and sufficient condition for trade to breakdown, and show that the entry of moldy lemons can trigger what we call exit cascades and a breakdown in market trades. Finally, we show that more precise information about agents' types makes markets more prone to exit cascades. The model is general, does not rely on institutional details or structure, and thus applicable to many different markets and contexts.

Knowing Your Lemon before You Dump It

Alessandro Pavan
,
Northwestern University

Abstract

In many games of interest (e.g., trade, entry, leadership, warfare, and partnership environments), one player (the leader) covertly acquires information about the state of Nature before choosing whether to engage with another player (the follower). The friendliness of the follower’s reaction depends on his beliefs about what motivated the leader’s choice to engage. We provide necessary and sufficient conditions for the leader’s value of acquiring more information to increase with the follower’s expectations. We then derive the economic implications of this characterization, focusing on three closely related topics (cognitive traps, disclosure, and cognitive styles), drawing policy implications.

Time Trumps Quantity in the Market for Lemons

William Fuchs
,
University of Texas-Austin and University Charles III of Madrid
Piero Gottardi
,
University of Essex and University of Venezia
Humberto Moreira
,
Getulio Vargas Foundation

Abstract

We consider a dynamic adverse selection model where privately informed sellers
of divisible assets can choose how much of their asset to sell at each point in time
to competitive buyers. With commitment, delay and lower quantities are equivalent
ways to signal higher quality. Only the discounted quantity traded is pinned down
in equilibrium. With spot contracts and observable past trades, there is a unique and
fully separating path of trades in equilibrium. Irrespective of the horizon and the
frequency of trades, the same welfare is attained by each seller type as in the commitment
case. When trades can take place continuously over time, each type trades
all of its assets at a unique point in time. Thus, only delay is used to signal higher
quality. When past trades are not observable, the equilibrium only coincides with the
one with public histories when trading can take place continuously over time.

Lemonade from Lemons: Information Design and Adverse Selection

Navin Kartik
,
Columbia University
Weijie Zhong
,
Stanford University

Abstract

A seller posts a price for a single object. The seller’s and buyer’s values may be interdependent. We characterize the set of payoff vectors across all information struc- tures. Simple feasibility and individual-rationality constraints identify the payoff set. The buyer can obtain the entire surplus; often, other mechanisms cannot enlarge the payoff set. We also study payoffs when the buyer is more informed than the seller, and when the buyer is fully informed. All three payoff sets coincide (only) in notable special cases—in particular, when there is complete breakdown in a “lemons market” with an uninformed seller and fully-informed buyer.
JEL Classifications
  • D8 - Information, Knowledge, and Uncertainty