The Role of Leasing under Adverse Selection
AbstractLeasing contracts are extensively used in durable goods markets. These contracts specify a rental rate and an option price at which the used good can be bought on termination of the lease. This option price cannot be controlled when the car is sold. We show that in a world in which quality is observable, this additional control variable is ineffective. Under adverse selection instead, leasing contracts affect equilibrium allocations in a way that matches observed behavior in the car market. Consistent with the data, our model predicts that leased cars have a higher turnover and that off-lease used cars are of higher quality. Moreover, the model predicts that the recent increase in leasing can be explained by the observed increase in car durability. We show that leasing contracts can improve welfare but that they are imperfect tools. We also show that a producer with market power can benefit from leasing contracts for two reasons: market segmentation and better pricing of the option. Moreover, despite the fact that lessors could structure contracts to prevent adverse selection, we show that this is not in their interest.
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Bibliographic InfoPaper provided by Economics Department, Princeton University in its series Princeton Economic Theory Papers with number 99f7.
Date of creation: Oct 1999
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Other versions of this item:
- 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
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