Cursedness in Markets with Asymmetric Information: Theory and Experimental Evidence

Abstract

Listen

Translate article

This paper analyzes limited strategic reasoning in posted-offer markets with asymmetric information. I use cursed equilibrium (Eyster and Rabin, 2005) to model buyers as making wrong inferences about quality based on the prices they observe. Such behavior increases trading frequencies, mitigating adverse selection in the market. However, it also leads to exploitative prices for low quality items and reduces consumer welfare. I test the model’s predictions experimentally, implementing variation in buyers’ strategic ability. All key predictions are supported in the data, documenting detrimental effects of limited strategic reasoning in markets and that the concept of cursedness organizes behavior remarkably well.