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Trading Dynamics with Private Buyer Signals in the Market for Lemons

Ayça Kaya and Kyungmin Kim

Review of Economic Studies, 2018, vol. 85, issue 4, 2318-2352

Abstract: We present a dynamic model of trading under adverse selection in which a seller sequentially meets buyers, each of whom receives a noisy signal about the quality of the seller’s asset and offers a price. We fully characterize the equilibrium trading dynamics and show that buyers’ beliefs about the quality of the asset can either increase or decrease over time, depending on the initial level. This result demonstrates how the introduction of private buyer signals enriches the set of trading patterns that can be accommodated within the framework of dynamic adverse selection, thereby broadening its applicability. We also examine the economic effects of search frictions and the informativeness of buyers’ signals in our model and discuss the robustness of our main insights in multiple directions.

Keywords: Adverse selection; Market for lemons; Inspection; Time-on-the-market (search for similar items in EconPapers)
JEL-codes: C73 C78 D82 (search for similar items in EconPapers)
Date: 2018
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