Inverse Adverse Selection: The Market for Gems

23 Pages Posted: 18 Aug 2010 Last revised: 30 Mar 2011

See all articles by Giuseppe Dari‐Mattiacci

Giuseppe Dari‐Mattiacci

University of Amsterdam; Tinbergen Institute

Sander Onderstal

University of Amsterdam; Tinbergen Institute

Francesco Parisi

University of Minnesota - Law School; University of Bologna

Date Written: January 25, 2011

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 market, contractual, and legal solutions. Our results show that auctions (competition among many informed buyers) provide a solution to the inverse adverse selection problem.

Keywords: Lemons, Gems, Adverse Selection, Asymmetric Information, Auction

JEL Classification: D44, D82, D86, K12

Suggested Citation

Dari-Mattiacci, Giuseppe and Onderstal, Sander and Parisi, Francesco, Inverse Adverse Selection: The Market for Gems (January 25, 2011). Minnesota Legal Studies Research Paper No. 10-47, Amsterdam Center for Law & Economics Working Paper No. 2010-04, Available at SSRN: https://ssrn.com/abstract=1661090 or http://dx.doi.org/10.2139/ssrn.1661090

Giuseppe Dari-Mattiacci (Contact Author)

University of Amsterdam ( email )

Postbus 15654
1001 ND
Amsterdam, Noord-Holland 1001 ND
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Sander Onderstal

University of Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Francesco Parisi

University of Minnesota - Law School ( email )

229 19th Avenue South
Minneapolis, MN 55455
United States

University of Bologna ( email )

Piazza Scaravilli 1
40126 Bologna, fc 47100
Italy

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