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Search costs and the severity of adverse selection

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  • Francesco Palazzo

    () (Bank of Italy)

Abstract

In view of some recent empirical evidence, I suggest a relationship between the magnitude of search costs and the severity of adverse selection in the context of a dynamic model with asymmetric information. In markets with small search costs sellers with low quality products misrepresent their quality and demand a high price. If instead search costs are not negligible and buyers receive sufficiently precise signals, sellers’ price offers are truthful and all product qualities are traded over time. In markets with small search costs, a budget balanced mechanism can avoid to exacerbate adverse selection: sellers should pay a per period market participation tax and receive a rebate after trading.

Suggested Citation

  • Francesco Palazzo, 2016. "Search costs and the severity of adverse selection," Temi di discussione (Economic working papers) 1073, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1073_16
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    References listed on IDEAS

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    More about this item

    Keywords

    dynamic adverse selection; decentralized markets; search theory; time on market observability;

    JEL classification:

    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • 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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