Adverse selection is overrated

An anonymous correspondent sends me news of the young Henry Schneider, Yale Ph.d. student.  Here is the abstract to his Estimating the Effects of Adverse Selection in Used Car Markets:

In this paper, I address the long-standing question of whether adverse selection prevents used
cars from reaching owners who value them most highly. In doing so, I confront the challenge
of identifying the effects of adverse selection separately from the effects of efficient sorting of
vehicles based on their conditions. This latter process would usually occur simultaneously to
adverse selection and also affects the distribution of vehicles that trade. Using the prediction
in Hendel and Lizzeri (1999), that adverse selection and efficient sorting both increase the
rate of price depreciation, I propose to use their joint effect as an upper bound on the effect of
adverse selection. My estimate of this joint effect, based on proprietary data on one million
dealer used car sales and trade-ins, is close to zero, a result that indicates that adverse selection
is unimportant. Using Consumer Expenditure Survey data, I provide additional support
for this conclusion by showing that vehicles that were recently purchased from a dealership
received approximately the same number of repairs as comparable continuously-held vehicles.
I conclude with a discussion of the role that sellers’ concerns for their reputations may play
in limiting information-based inefficiencies.

But Henry is no apologist for the market.  Here is his paper on how much auto mechanics rip you off.  Half of all the money spent on auto mechanics appears to be deadweight loss.  He does note they neglect urgent problems 77 percent of the time, which suggests some stupidity instead of (in addition to?) pure venality.

Here is Alex’s earlier post on adverse selection.


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