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Inverse Adverse Selection: The Market for Gems

Author

Listed:
  • Giuseppe Dari-Mattiacci

    (University of Amsterdam)

  • Sander Onderstal

    (University of Amsterdam)

  • Francesco Parisi

    (University of Minnesota, and University of Bologna)

Abstract
This paper studies markets plagued with asymmetric information on the quality of traded goods. In Akerlof's setting, sellers are better informed than buyers. In contrast, we examine cases where buyers are better informed than sellers. This creates an inverse adverse selection problem: The market tends to disappear from the bottom rather than from the top. In contrast to the traditional model, it is the high-value goods (gems) that are traded on the market, rather than the low-value goods (lemons). We investigate the consequences of this inverse adverse selection and its potential solutions. The uninformed buyer in a traditional market for lemons experiences the quality of the good he purchased; instead, the uninformed seller may never know the quality of the good that he sold. This renders the conventional legal and contractual solutions to the lemons problem often ineffective in the gems case. We further explore the theoretical and practical appeal of m arket, contractual, and legal solutions. Our results show that auctions (competition among many informed buyers) provide a solution to the inverse adverse selection problem.

Suggested Citation

  • Giuseppe Dari-Mattiacci & Sander Onderstal & Francesco Parisi, 2011. "Inverse Adverse Selection: The Market for Gems," Tinbergen Institute Discussion Papers 11-017/1, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20110017
    as

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    File URL: https://papers.tinbergen.nl/11017.pdf
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    References listed on IDEAS

    as
    1. Bebchuk, Lucian Ayre & Shavell, Steven, 1991. "Information and the Scope of Liability for Breach of Contract: The Rule of Hadley vs. Baxendale," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(2), pages 284-312, Fall.
    2. Krishna, Vijay, 2009. "Auction Theory," Elsevier Monographs, Elsevier, edition 2, number 9780123745071.
    3. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    4. Manelli, Alejandro M & Vincent, Daniel R, 1995. "Optimal Procurement Mechanisms," Econometrica, Econometric Society, vol. 63(3), pages 591-620, May.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Mike Burkart & Samuel Lee, 2016. "Smart Buyers," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 5(2), pages 239-270.
    2. Schneider, Mark & Stephenson, Daniel Graydon, 2021. "Bargains, price signaling, and efficiency in markets with asymmetric information," Games and Economic Behavior, Elsevier, vol. 128(C), pages 160-181.

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    More about this item

    Keywords

    Lemons; Gems; Adverse selection; Asymmetric information; Auction;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law

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