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Extreme Adverse Selection, Competitive Pricing, and Market Breakdown

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Abstract

Extreme adverse selection arises when private information has unbounded support, and market breakdown occurs when no trade is the only equilibrium outcome. We study extreme adverse selection via the limit behavior of a financial market as the support of private information converges to an unbounded support. A necessary and sufficient condition for market breakdown is obtained. If the condition fails, then there exists competitive market behavior that converges to positive levels of trade whenever it is first best to have trade. When the condition fails, no feasible (competitive or not) market behavior converges to positive levels of trade.

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File URL: http://cowles.econ.yale.edu/P/cd/d15b/d1573.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1573.

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Length: 46 pages
Date of creation: Jul 2006
Date of revision:
Handle: RePEc:cwl:cwldpp:1573

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Web page: http://cowles.econ.yale.edu/
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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Adverse selection; Market breakdown; Separation; Competitive pricing;

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