Dynamic Adverse Selection and the Size of the Informed Side of the Market
AbstractIn this paper we examine the problem of dynamic adverse selection in a stylized market where the quality of goods is a seller’s private information. We show that in equilibrium all goods can be traded if a simple piece of information is made publicly available: the size of the informed side of the market. Moreover, we show that if exchanges can take place frequently enough, then agents roughly enjoy the entire potential surplus from exchanges. We illustrate these findings with a dynamic model of trade where buyers and sellers repeatedly interact over time. More precisely we prove that, if the size of the informed side of the market is a public information at each trading stage, then there exists a weak perfect Bayesian equilibrium where all goods are sold in finite time and where the price and quality of traded goods are increasing over time. Moreover, we show that as the time between exchanges becomes arbitrarily small, full trade still obtains in finite time – i.e., all goods are actually traded in equilibrium – while total surplus from exchanges converges to the entire potential. These results suggest two policy interventions in markets suffering from dynamic adverse selection: first, the public disclosure of the size of the informed side of the market in each trading stage and, second, the increase of the frequency of trading stages.
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Bibliographic InfoPaper provided by University of Modena and Reggio E., Dept. of Economics in its series Center for Economic Research (RECent) with number 057.
Length: pages 21
Date of creation: Mar 2011
Date of revision:
dynamic adverse selection; full trade; size of the informed side; frequency of exchanges; asymmetric information;
Other versions of this item:
- Ennio Bilancini & Leonardo boncinelli, 2011. "Dynamic Adverse Selection and the Size of the Informed Side of the Market," Department of Economics 0650, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-02 (All new papers)
- NEP-COM-2011-04-02 (Industrial Competition)
- NEP-CTA-2011-04-02 (Contract Theory & Applications)
- NEP-MST-2011-04-02 (Market Microstructure)
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