Screening and Adverse Selection in Frictional Markets

77 Pages Posted: 26 Dec 2016

See all articles by Benjamin R. Lester

Benjamin R. Lester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Ali Shourideh

University of Pennsylvania - Finance Department

Venky Venkateswaran

New York University (NYU) - Leonard N. Stern School of Business; Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Ariel Zetlin-Jones

Carnegie Mellon University; Federal Reserve Bank of Minneapolis

Multiple version iconThere are 3 versions of this paper

Date Written: March 10, 2016

Abstract

We incorporate a search-theoretic model of imperfect competition into an otherwise standard model of asymmetric information with unrestricted contracts. We develop a methodology that allows for a sharp analytical characterization of the unique equilibrium, and then use this characterization to explore the interaction between adverse selection, screening, and imperfect competition. On the positive side, we show how the structure of equilibrium contracts — and hence the relationship between an agent’s type, the quantity he trades, and the corresponding price — are jointly determined by the severity of adverse selection and the concentration of market power. This suggests that quantifying the effects of adverse selection requires controlling for the market structure. On the normative side, we show that increasing competition and reducing informational asymmetries can be detrimental to welfare. This suggests that recent attempts to increase competition and reduce opacity in markets that suffer from adverse selection could potentially have negative, unforeseen consequences.

Suggested Citation

Lester, Benjamin R. and Shourideh, Ali and Venkateswaran, Venky and Venkateswaran, Venky and Zetlin-Jones, Ariel, Screening and Adverse Selection in Frictional Markets (March 10, 2016). Available at SSRN: https://ssrn.com/abstract=2889493 or http://dx.doi.org/10.2139/ssrn.2889493

Benjamin R. Lester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

HOME PAGE: http://sites.google.com/site/benjaminrlester

Ali Shourideh

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Venky Venkateswaran (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

New York University (NYU) - Leonard N. Stern School of Business ( email )

Suite 9-160
New York, NY
United States

Ariel Zetlin-Jones

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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