Search With Adverse Selection

Abstract

This paper analyzes a search model with asymmetric information of the common values variety. The basic features of this environment resemble those of a common values (procurement) auction, except that the searcher in our model, who is the counterpart of the auctioneer in the auction model, encounters trading partners through costly sequential search. The main objective is to understand how the combination of search activity and information asymmetry affects prices and welfare. We specifically inquire about the extent of information aggregation by the price –how close the equilibrium prices are to the full information prices–when the search frictions are small. Roughly speaking, we conclude that information is aggregated less well in the search environment than it is in the corresponding auction environment. We trace this to a stronger form of winner’s curse that is present in the search scenario. This understanding is a central qualitative insight of this paper, which is likely to have implications beyond the narrow confines of our model. We also look at the efficiency perspective and examine the relations between total surplus and the informativenss of the signal technology available to the uninformed. We conclude that total surplus is not monotone in the quality of the signals.

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