Working Paper: NBER ID: w21833
Authors: Benjamin Lester; Ali Shourideh; Venky Venkateswaran; Ariel Zetlin-Jones
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. 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—is 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. We also 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.
Keywords: adverse selection; imperfect competition; screening; welfare; market structure
JEL Codes: D41; D42; D43; D82; D83; D86; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| severity of adverse selection (D82) | structure of equilibrium contracts (D86) |
| concentration of market power (L11) | structure of equilibrium contracts (D86) |
| increased competition (L13) | adverse selection severity (D82) |
| reduced informational asymmetries (D82) | adverse selection severity (D82) |
| increased competition and reduced informational asymmetries (L13) | welfare outcomes (I38) |
| market power concentration and adverse selection severity (D82) | welfare outcomes (I38) |
| intense competition or severe adverse selection (D82) | equilibrium offers (D50) |
| sufficient market power and mild adverse selection (D82) | pooling occurs (C59) |
| promoting competition or reducing opacity (L13) | negative unforeseen consequences (F69) |
| adverse selection severity (D82) | welfare outcomes (I38) |
| market power concentration (L11) | welfare outcomes (I38) |