Endogenous Lemon Markets: Risky Choices and Adverse Selection

Avi Lichtig, Ran Weksler

Research output: Contribution to journalArticlepeer-review

Abstract

The severity of adverse selection depends, to a great extent, on the underlying distribution of the asset. This distribution is commonly modeled as exogenous; however, in many real-world applications, it is determined endogenously. A natural question in this context is whether one can predict the severity of the adverse selection problem in such environments. In this paper, we study a bilateral trade model in which the distribution of the asset is affected by pre-trade unobservable actions of the seller. Analyzing general trade mechanisms, we show that the seller's actions are characterized by a risk-seeking disposition. In addition, we show that (location-independent) riskier underlying distributions of the asset induce lower social welfare. That is, “lemon markets” arise endogenously in these environments.

Original languageEnglish
Pages (from-to)413-454
Number of pages42
JournalJournal of the European Economic Association
Volume21
Issue number2
DOIs
StatePublished - 1 Apr 2023

Bibliographical note

Funding Information:
We are grateful to Ilan Kremer for his guidance and dedication throughout this project. We also wish to thank Elchanan Ben-Porath, Francesc Dilmé, Sivan Frenkel, Alex Gershkov, Sergiu Hart, Stephan Lauermann, Jeffrey Mensch, Benny Moldovanu, Binyamin Oz, Motty Perry, Yosef Rinott, Amnon Schreiber, Andy Skrzypacz, Boaz Zik, and various other seminar participants. Lichtig gratefully acknowledges funding from the German Research Foundation (DFG) through CRC TR 224 (Project B01).

Publisher Copyright:
© The Author(s) 2022. Published by Oxford University Press on behalf of European Economic Association. All rights reserved.

ASJC Scopus subject areas

  • Economics, Econometrics and Finance (all)

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