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Too much trade: A problem of adverse selection

de Meza, David and Reito, Francesco and Reyniers, Diane (2021): Too much trade: A problem of adverse selection.

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Abstract

It is shown that uni-dimensional adverse selection may result in market expansion beyond the full-information level. Although bad types tend to drive out good, enough good types may remain to draw in excessive numbers of bad types. As a result, the welfare loss from adverse selection is potentially underestimated. Applications are made to insurance, credit and the used car market.

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