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Overconfidence in the Markets for Lemons
Author(s) -
Herweg Fabian,
Müller Daniel
Publication year - 2016
Publication title -
the scandinavian journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.725
H-Index - 64
eISSN - 1467-9442
pISSN - 0347-0520
DOI - 10.1111/sjoe.12135
Subject(s) - overconfidence effect , adverse selection , economics , information asymmetry , microeconomics , quality (philosophy) , value (mathematics) , outcome (game theory) , computer science , philosophy , epistemology , machine learning , psychology , social psychology
We extend Akerlof's “Market for Lemons” (1970, Quarterly Journal of Economics 84 , 488–500) by assuming that some buyers are overconfident. Buyers in our model receive a noisy signal about the quality of the good that is on display for sale. Overconfident buyers do not update according to Bayes' rule but take the noisy signal at face value. We show that the presence of overconfident buyers can stabilize the market outcome by preventing total adverse selection. However, this stabilization comes at a cost: rational buyers are crowded out of the market.