A Note on Adverse Selection and Bounded Rationality

Takeshi Murooka and Takuro Yamashita
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Takeshi Murooka: Osaka School of International Public Policy, Osaka University

No 20E002, OSIPP Discussion Paper from Osaka School of International Public Policy, Osaka University

Abstract: There is accumulating evidence that some consumers are behavioral in the sense that they may make suboptimal decisions. This paper investigates adverse selection with general types of such behavioral biases. In our model, some buyers (i.e., consumers) may take actions that do not necessary optimize own payoffs, which encompass virtually any type of biases including subjective probability,framing, model misspecification, random errors, and inferential naivety. We focus on a situation in which there exists severe adverse selection where only no-trade outcome is possible under rational agents. We show that the no-trade theorem remains to hold without imposing any additional assumption on buyers' behavior. That is, if there is any trade under a mechanism which is incentive compatible for sellers, then the expected payoff from the trade is negative (i.e., ex ante individual rationality constraint is violated) for some type of buyers. Our result sheds light on a new trade-off between social surplus and payoff losses of boundedly-rational buyers.

Keywords: adverse selection; bounded rationality; mechanism design; no-trade theorem (search for similar items in EconPapers)
JEL-codes: D82 D83 D86 D90 D91 (search for similar items in EconPapers)
Pages: 7 pages
Date: 2020-03
New Economics Papers: this item is included in nep-cbe, nep-des, nep-hpe, nep-mic and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Working Paper: A Note on Adverse Selection and Bounded Rationality (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:osp:wpaper:20e002

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