Inverse Adverse Selection: The Market for Gems

Abstract

AbstractThis paper studies markets plagued with asymmetric information onthe quality of the goods traded. In Akerlof’s setting, sellers are betterinformed than buyers. In contrast, we examine cases where buyers arebetter informed than sellers. This creates an inverse adverse-selectionproblem: The market tends to disappear from the bottom rather thanfrom the top. In contrast to the traditional model, it is the high-valuegoods (gems) that remain longer on the market, rather than the low-value goods (lemons). We investigate the consequences of this inverseadverse-selection and its potential solutions. The uninformed buyer ina traditional market for lemons experiences the qualities of the good hepurchased; instead, the uninformed seller may never realize the quality ofthe good that he sold. This renders conventional warranties and some ofthe other market and legal solutions to the lemons problem ineffective inthe gems case. We explore the way in which screening, signaling, legalduties, auctions, and keeping experts offthe market may mitigate aninverse adverse-selection problem.JEL codes: D44, D82, D86, K12.Keywords: lemons, gems, adverse selection, asymmetric information,auction