An Exploration of Competitive Signalling Equilibria with 'Third Party' Information Production: The Case of Debt Insurance
In markets in which sellers know more about product quality than buyers, but cannot convey their superior information either by directly issuing costly signals of the Spence type or by successfully funding the production of information, I suggest another way in which the informational asymmetry problem can be resolved; a third party can produce the necessary information at a cost and use it to price a service consumed by the sellers. Buyers can then observe a seller's choice of service consumption level and be well informed in equilibrium. In this framework I construct a model in which a borrower's choice of insurance coverage signals its default probability to lenders, and explore the properties of the resulting signalling equilibrium in a variety of cases.
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