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Meet the lemons: An experiment on how cheap-talk overcomes adverse selection in decentralized markets

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  • Siegenthaler, Simon

Abstract

We report on an experiment on decentralized markets in the presence of adverse selection. When allowing for costless and non-binding communication (cheap-talk), there exists a partially separating equilibrium that results in a substantially higher efficiency level than the adverse selection benchmark. The partially separating equilibrium hinges on the presence of matching frictions, which create a trade-off for low quality sellers between successfully mimicking high quality sellers and an increased matching probability if they truthfully reveal their type. The experimental results reflect the theoretical predictions of the partially separating equilibrium: communication is informative and improves efficiency compared to the benchmark without cheap-talk. We conduct control treatments to show that truth-telling is not explained by lying aversion or pro-social preferences, but is due to the pecuniary incentives of the partially separating equilibrium.

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  • Siegenthaler, Simon, 2017. "Meet the lemons: An experiment on how cheap-talk overcomes adverse selection in decentralized markets," Games and Economic Behavior, Elsevier, vol. 102(C), pages 147-161.
    • Handle: RePEc:eee:gamebe:v:102:y:2017:i:c:p:147-161
    DOI: 10.1016/j.geb.2016.11.001
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    2. Dong Yan & Christian A. Vossler & Scott M. Gilpatric, 2020. "Product quality and third-party certification in potential lemons markets," Working Papers 2020-04, University of Tennessee, Department of Economics.
    3. Volker Benndorf, 2018. "Voluntary Disclosure of Private Information and Unraveling in the Market for Lemons: An Experiment," Games, MDPI, vol. 9(2), pages 1-17, May.
    4. Lee, Jaesun & Shapiro, Dmitry, 2023. "Quality communication via cheap-talk messages in experimental auctions," Journal of Economic Behavior & Organization, Elsevier, vol. 212(C), pages 74-107.
    5. Hyndman, Kyle, 2021. "Dissolving partnerships under risk: An experimental investigation," Journal of Economic Behavior & Organization, Elsevier, vol. 185(C), pages 702-720.
    6. Dmitry A. Shapiro & Jaesun Lee, 2022. "Revealing Negative Information in Monopoly and Duopoly Settings: Experimental Analysis," Korean Economic Review, Korean Economic Association, vol. 38, pages 167-205.
    7. Dariel, Aurelie & Riedl, Arno & Siegenthaler, Simon, 2021. "Referral hiring and wage formation in a market with adverse selection," Games and Economic Behavior, Elsevier, vol. 130(C), pages 109-130.
    8. Surajeet Chakravarty & Todd R. Kaplan & Luke Lindsay, 2020. "Increasing Employment Through the Partial Release of Information," Discussion Papers 2001, University of Exeter, Department of Economics, revised 2023.

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    More about this item

    Keywords

    Adverse selection; Cheap-talk; Decentralized markets; Experiment; Frictions; Information transmission; Market for lemons;
    All these keywords.

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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