Adverse selection and bounded rationality: an impossibility theorem

Abstract

We consider an adverse selection environment between an informed seller and an uninformed buyer, where no trade occurs when all buyers are the standard Bayesian-rational type. The buyer may be a “behavioral” type in that he may take actions different from the rational type. We show that, for any incentive-feasible mechanism with any non-trivial trade, the buyer’s ex-ante expected payoff is strictly negative. Our result implies that whenever trade occurs, some behavioral types must incur losses—highlighting a new trade-off between social surplus and buyer protection.

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Reference

Takuro Yamashita, and Takeshi Murooka, “Adverse selection and bounded rationality: an impossibility theorem”, Japanese Economic Review, September 2022.