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Meet the lemons: An experiment on how cheap-talk overcomes adverse selection in decentralized markets

Simon Siegenthaler ()

Games and Economic Behavior, 2017, vol. 102, issue C, 147-161

Abstract: We report on an experiment on decentralized markets in the presence of adverse selection. When allowing for costless and non-binding communication (cheap-talk), there exists a partially separating equilibrium that results in a substantially higher efficiency level than the adverse selection benchmark. The partially separating equilibrium hinges on the presence of matching frictions, which create a trade-off for low quality sellers between successfully mimicking high quality sellers and an increased matching probability if they truthfully reveal their type. The experimental results reflect the theoretical predictions of the partially separating equilibrium: communication is informative and improves efficiency compared to the benchmark without cheap-talk. We conduct control treatments to show that truth-telling is not explained by lying aversion or pro-social preferences, but is due to the pecuniary incentives of the partially separating equilibrium.

Keywords: Adverse selection; Cheap-talk; Decentralized markets; Experiment; Frictions; Information transmission; Market for lemons (search for similar items in EconPapers)
JEL-codes: C78 C91 D82 D83 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.geb.2016.11.001

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