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Overconfidence in the Markets for Lemons

  • Herweg, Fabian
  • Müller, Daniel

We extend Akerlof (1970)’s “Market for Lemons†by assuming that some buyers are overconfident. Buyers in our model receive a noisy signal about the quality of the good that is on display for sale. Overconfident buyers do not update according to Bayes’ rule but take the noisy signal at face value. We show that the presence of overconfident buyers can stabilize the market outcome by preventing total adverse selection. This stabilization, however, comes at a cost: rational buyers are crowded out of the market.

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Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 452.

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Date of creation: 17 Dec 2013
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Handle: RePEc:trf:wpaper:452
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  1. de la Rosa, Leonidas Enrique, 2011. "Overconfidence and moral hazard," Games and Economic Behavior, Elsevier, vol. 73(2), pages 429-451.
  2. Michael D. Grubb, 2006. "Selling to Overconfident Consumers," Discussion Papers 06-018, Stanford Institute for Economic Policy Research.
  3. Francesco Squintani & Alvaro Sandroni, 2007. "Overconfidence, Insurance and Paternalism," Economics Discussion Papers 643, University of Essex, Department of Economics.
  4. Hanming Fang & Giuseppe Moscarini, 2004. "Morale Hazard," Yale School of Management Working Papers ysm386, Yale School of Management.
  5. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
  6. Charles Wilson, 1980. "The Nature of Equilibrium in Markets with Adverse Selection," Bell Journal of Economics, The RAND Corporation, vol. 11(1), pages 108-130, Spring.
  7. Ellingsen, Tore, 1997. "Price signals quality: The case of perfectly inelastic demand," International Journal of Industrial Organization, Elsevier, vol. 16(1), pages 43-61, November.
  8. Gregory Lewis, 2011. "Asymmetric Information, Adverse Selection and Online Disclosure: The Case of eBay Motors," American Economic Review, American Economic Association, vol. 101(4), pages 1535-46, June.
  9. Bond, Eric W, 1982. "A Direct Test of the "Lemons" Model: The Market for Used Pickup Trucks," American Economic Review, American Economic Association, vol. 72(4), pages 836-40, September.
  10. Genesove, David, 1993. "Adverse Selection in the Wholesale Used Car Market," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 644-65, August.
  11. Adriani, Fabrizio & Deidda, Luca G., 2009. "Price signaling and the strategic benefits of price rigidities," Games and Economic Behavior, Elsevier, vol. 67(2), pages 335-350, November.
  12. Englmaier, Florian, 2010. "Managerial Optimism and Investment Choice," Munich Reprints in Economics 22026, University of Munich, Department of Economics.
  13. Levin, Jonathan, 2001. "Information and the Market for Lemons," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 657-66, Winter.
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