On the Impact of Misvaluation on Bilateral Trading

Subjective biases and errors systematically affect market equilibria, whether at the population level or in bilateral trading. Here, we consider the possibility that an agent engaged in bilateral trading is mistaken about her own value of the good she expects to trade. Although it may sound paradoxical that a subjective private valuation is something an agent can be mistaken about, as it is up to her to fix it, we consider the case in which that agent, seller or buyer, consciously or not, given the structure of a market, a type of goods, and a temporary lack of information, may, more or less consciously, state an erroneous valuation. The typical context through which this possibility may arise is in relation with so-called experience goods which are sold while all their intrinsic qualities are still unknown (like, e.g. untasted bottled fine wines). We model that “private misvaluation” phenomenon. The agents can also be mistaken about how their exchange counterparts are themselves mistaken. We analyse and simulate the consequences of first-order and second-order private misvaluation on market equilibria and bubbles, and notably focus on the context where the second-order expectations about the other agent’s misvaluation are not met.