Since Akerlof’s (1970) seminal paper the existence of adverse selection due to asymmetric information about quality is well-understood. Given the negative implications for trading and welfare, the question arises of how such markets come into existence. We consider a market in which firms make observable investment/entry decisions that generate products of a quality that becomes known only to t...

I consider a real business cycle model in which agents have private information about an idiosyncratic shock to their value of leisure. I consider the mechanism design problem for this economy and describe a computational method to solve it. This is an important contribution of the paper since the method could be used to solve a wide class of models with heterogeneous agents and aggregate uncer...

How can the worsening of a small part of the loan market lead to a crash as well as a prolonged depression in secondary loan prices, bank equity prices, and lending activity? This paper seeks to answer this question. We present a model in which banks issue long-term loans and finance them with repurchase agreements (“repos”) from short-term lenders in order to leverage up their equity. Banks di...

An important feature of financial markets is that securities are traded repeatedly by asymmetrically informed investors. We study how current and future adverse selection affect the required return. We find that the bid-ask spread generated by adverse selection is not a cost, on average, for agents who trade, and hence the bid-ask spread does not directly influence the required return. Adverse ...

This paper considers a market with adverse selection in the spirit of Rothschild and Stiglitz [20]. The major departure from existing approaches is that we model a decentralized market that is open-ended and constantly refilled by new participants, e.g., by new workers and firms in the case of a labor market. The major novelty of this approach is that the distribution of types in the market bec...

This paper analyzes the interaction of fairness concerns and social comparisons with asymmetric information and incentives within the context of a firm’s employment decision. It studies optimal, incentive-compatible employment contracts if each worker is inequity averse he suffers from being ‘worse off’ than his colleagues and has private information about his productivity. Inequity aversion is...

This article develops and discusses a framework for estimating losses due to adverse selection in insurance. It is shown that expected losses depend only on means, variances and covariances of insurance factors and rates of uptake of insurance. Percentage loadings required to avoid losses are displayed. Application is made to Huntingdon disease where individuals either have the genetic marker o...

We present a model of the market for a used durable in which agents face ...xed costs of adjustment, the magnitude of which depends on the degree of adverse selection in the secondary market. We ...nd that, unlike typical models, the sS bands in our model contract as the variance of the shock process increases. We also analyze a dynamic version of the model in which agents are allowed to make d...

We develop a model of nonstationary relational contracts in order to study internal wage dynamics. Workers are heterogeneous and each worker’s ability is both private information and fixed for all time. Learning therefore occurs within employment relationships. The inferences, however, are confounded by moral hazard: the distribution of output is determined by both the worker’s type and by his ...

Consumer groups fear that the use of genetic testing information in insurance underwriting might lead to the creation of an underclass of individuals who cannot obtain insurance; thus, these groups want to ban insurance companies from accessing genetic test results. Insurers contend that such a ban might lead to adverse selection that could threaten their financial solvency. To investigate the ...