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Search costs and the severity of adverse selection

Francesco Palazzo

Research in Economics, 2017, vol. 71, issue 1, 171-197

Abstract: In view of some recent empirical evidence, I suggest a relationship between the magnitude of search costs and the severity of adverse selection in the context of a dynamic model with asymmetric information. In markets with small search costs sellers with low quality products misrepresent their quality and demand a high price. If search costs are not negligible, sellers׳ price offers are truthful and all product qualities are traded over time. In markets with small search costs, a budget balanced mechanism can mitigate adverse selection: sellers should pay a per period market participation tax and receive a rebate after trading.

Keywords: Dynamic adverse selection; Decentralized markets; Search theory; Time on market observability (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.rie.2016.09.001

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