Adverse selection versus hold up: Tenure choice, tenancy protection and equilibrium in housing markets

Abstract

In this paper, we consider the tenure choice problem under different schemes of legal tenancy protection. We analyze the interaction between the rental and resale housing markets under conditions of bilateral asymmetric information regarding housing quality and the type of residents. Home ownership is associated with a trade-off between the loss caused by asymmetric information and rent exploitation by landlords in a holdup problem. With perfect protection for tenants, adverse selection in the resale housing market becomes problematic, and the market disappears. Conversely, the absence of tenancy protection mitigates adverse selection in the resale housing market and leads to a separating equilibrium.