Finance and Economics Discussion Series (FEDS)
March 2022
Moldy Lemons and Market Shutdowns
Jin-Wook Chang, R. Matthew Darst
Abstract:
This paper studies competitive market shutdowns due to adverse selection, where sellers post nonexclusive menus of contracts. We first show that the presence of the worst type of agents (moldy lemons) causes markets to fail only if their mass is sufficiently large. We then show that a small mass of moldy lemons can lead to a large cascade of exits when buyers possess outside options. Finally, we show that more precise information about agents' types makes markets more prone to exit cascades. The model is general and does not rely on institution details or structure, and thus can be applied to many different markets and context.
Note: The title of this paper was updated after initial publication.
DOI: https://doi.org/10.17016/FEDS.2022.013
PDF: Full Paper
Related Materials: Accessible materials (.zip)
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.