Sorting versus Screening in Decentralized Markets with Adverse Selection

Abstract

We study the role of traders' meeting capacities in decentralized markets with adverse selection. Uninformed principals choose trading mechanisms to find an agent with whom to trade. Agents are privately informed about their quality and aim to match with one of the principals. We consider a rich set of meeting technologies and characterize the properties of the equilibrium allocations for each of them. In equilibrium, different agent types can be separated either via sorting—they self-select into different submarkets—or screening within the trading mechanism, or a combination of the two. We show that, as the meeting capacity increases, the equilibrium features more screening and less sorting. Interestingly, this increases price variability and reduces the average quality of trade as well as the total level of trade in the economy. The trading losses are, however, more than compensated by savings in entry costs so that welfare increases.