The Social Costs of Side Trading
20 Pages Posted: 10 Jul 2019
Date Written: June 7, 2019
We study resource allocation under private information when the planner cannot prevent bilateral side trading between consumers and firms. Adverse selection and side trading severely restrict feasible trades, as each marginal quantity must be fairly priced given the consumer types who purchase it. The resulting social costs are twofold. First, second-best efficiency and robustness to side trading are in general irreconcilable requirements. Second, there actually exists a unique budget-feasible allocation robust to side trading, which deprives the planner from any capacity to redistribute resources between different types of consumers. We discuss the relevance of our results for insurance and financial markets.
Keywords: Adverse Selection, Side Trading, Second-Best Allocations
JEL Classification: D43, D82, D86
Suggested Citation: Suggested Citation