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An sS Model with Adverse Selection

  • Christopher L. House
  • John V. Leahy

We present a model of the market for used cars in which agents face a fixed cost of adjustment, the magnitude of which depend on the degree of adverse selection in the secondary market. We find that, unlike typical models, the sS bands in our model contract as the variance of the shock process increases. We also analyze a dynamic version of the model in which agents are allowed to make decisions that are conditional of the age of a used car. We find that, as a car ages, the lemons problem tends to decline in importance, and the sS bands contract.

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File URL: http://www.nber.org/papers/w8030.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8030.

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Date of creation: Dec 2000
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Publication status: published as Christopher L. House & John V. Leahy, 2004. "An sS Model with Adverse Selection," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 581-614, June.
Handle: RePEc:nbr:nberwo:8030
Note: EFG
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  1. Christopher D. Carroll & Wendy E. Dunn, 1997. "Unemployment Expectations, Jumping (S,s) Triggers, and Household Balance Sheets," NBER Working Papers 6081, National Bureau of Economic Research, Inc.
  2. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296 National Bureau of Economic Research, Inc.
  3. John V. Leahy & Joseph Zeira, 2005. "The Timing of Purchases and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 72(4), pages 1127-1151.
  4. Grossman, Sanford J & Laroque, Guy, 1990. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Econometrica, Econometric Society, vol. 58(1), pages 25-51, January.
  5. Eberly, Janice C, 1994. "Adjustment of Consumers' Durables Stocks: Evidence from Automobile Purchases," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 403-36, June.
  6. Abel, Andrew B., 1952-, 1995. "Options, the value of capital, and investment," Working papers 3843-95., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  7. Caballero, R.J., 1990. "Durable Goods: An Explanation For Their Slow Adjustment," Discussion Papers 1990_49, Columbia University, Department of Economics.
  8. Max Blouin, 2000. "Overlapping Generations of Cars," Cahiers de recherche CREFE / CREFE Working Papers 117, CREFE, Université du Québec à Montréal.
  9. Caballero, Ricardo J, 1994. "Notes on the Theory and Evidence on Aggregate Purchases of Durable Goods," Oxford Review of Economic Policy, Oxford University Press, vol. 10(2), pages 107-17, Summer.
  10. Leif Danziger, 1998. "A Dynamic Economy with Costly Price Adjustment," Cahiers de recherche CREFE / CREFE Working Papers 83, CREFE, Université du Québec à Montréal.
  11. Andrew Caplin & John Leahy, 1999. "Durable Goods Cycles," NBER Working Papers 6987, National Bureau of Economic Research, Inc.
  12. Igal Hendel & Alessandro Lizzeri, 1997. "Adverse Selection in Durable Goods Markets," NBER Working Papers 6194, National Bureau of Economic Research, Inc.
  13. Milgrom, Paul & Roberts, John, 1994. "Comparing Equilibria," American Economic Review, American Economic Association, vol. 84(3), pages 441-59, June.
  14. Andrea L. Eisfeldt, 2004. "Endogenous Liquidity in Asset Markets," Journal of Finance, American Finance Association, vol. 59(1), pages 1-30, 02.
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