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Abstract
In this paper we examine the problem of dynamic adverse selection in a stylized market where the quality of goods is a seller׳s private information while the realized distribution of qualities is public information. We obtain that full trade occurs in every dynamic competitive equilibrium. Moreover, we show that if prices can be conditioned on the supply size then a dynamic competitive equilibrium always exists, while it fails to exist if prices cannot be conditioned on the supply size and the frequency of exchanges is high enough. We conclude that the possibility to condition prices on the supply size allows us to reach efficiency in the limit for exchanges becoming more and more frequent, while otherwise the welfare loss due to delays of exchanges remains bounded away from zero.
Highlights
Since the publication of the seminal work by Akerlof (1970), the problem of adverse selection has been widely investigated by economic theorists
In this paper we examine the problem of dynamic adverse selection in a stylized market where the quality of goods is a seller’s private information while the realized distribution of qualities is public information
We argue that intertemporal competition among buyers as well as intertemporal competition between one buyer and herself in the past can sustain equilibria where full trade does not emerge; in particular, we argue that this possibility arises when buyers can condition current price offers to past price offers, and we show that in three cases where intertemporal competition is at least partly impeded – i.e., buyers stay on the market just one trading stage, agents are extremely impatient, adverse selection is extreme – all weak perfect Bayesian equilibria lead to full trade
Summary
Since the publication of the seminal work by Akerlof (1970), the problem of adverse selection has been widely investigated by economic theorists. Another important issue is whether the public knowledge of the supply size is sufficient to let agents enjoy the whole potential surplus from exchanges, as would happen in the absence of asymmetric information on the quality of goods This desirable outcome in general is not guaranteed because sequential trade may take a substantial amount of time and, agents might be forced to wait long periods before enjoying their payoff which, reasonably, would be discounted . We relax the assumption of public knowledge of the realized distribution of qualities by allowing each good to be randomly drawn from an interval of qualities, with intervals potentially overlapping; we prove that if trading stages take place frequently enough, there exists a weak perfect Bayesian equilibrium that leads to full trade under incomplete information on the distribution of qualities. We refer the reader to the last section of the paper for a detailed discussion of the relation between the present paper and the existing literature on adverse selection
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