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Screening and adverse selection in frictional markets

Author

Listed:
  • Benjamin Lester
  • Ali Shourideh
  • Venky Venkateswaran
  • Ariel Zetlin-Jones

Abstract

We incorporate a search-theoretic model of imperfect competition into an otherwise standard model of asymmetric information with unrestricted contracts. We develop a methodology that allows for a sharp analytical characterization of the unique equilibrium and then use this characterization to explore the interaction between adverse selection, screening, and imperfect competition. On the positive side, we show how the structure of equilibrium contracts?and, hence, the relationship between an agent?s type, the quantity he trades, and the corresponding price?is jointly determined by the severity of adverse selection and the concentration of market power. This suggests that quantifying the effects of adverse selection requires controlling for the market structure. On the normative side, we show that increasing competition and reducing informational asymmetries can be detrimental to welfare. This suggests that recent attempts to increase competition and reduce opacity in markets that suffer from adverse selection could potentially have negative, unforeseen consequences

Suggested Citation

  • Benjamin Lester & Ali Shourideh & Venky Venkateswaran & Ariel Zetlin-Jones, 2016. "Screening and adverse selection in frictional markets," Working Papers 16-10, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:16-10
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Adverse selection; Imperfect competition; Screening; Transparency; Search theory;
    All these keywords.

    JEL classification:

    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • 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
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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