Inverse Adverse Selection: The Market for Gems

This paper studies markets plagued with asymmetric information on the quality of the goods traded. 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 remain longer on the market, rather than the lowvalue 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 qualities of the good he purchased; instead, the uninformed seller may never realize the quality of the good that he sold. This renders conventional warranties and some of the other market and legal solutions to the lemons problem ineffective in the gems case. We explore the way in which screening, signaling, legal duties, auctions, and keeping experts off the market may mitigate an inverse adverse-selection problem. JEL codes: D44, D82, D86, K12.