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Overconfidence in the Market for Lemons

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  • Herweg, Fabian
  • Müller, Daniel

Abstract

We extend Akerlof ’s (1970) “Market for Lemons” by assuming that some buyers are overconfident. Buyers in our model receive a noisy signal about the quality of the good that is at display for sale. Overconfident buyers do not update according to Bayes’ rule but take the noisy signal at face value. The main finding is that the presence of overconfident buyers can stabilize the market outcome by preventing total adverse selection. This stabilization, however, comes at a cost: rational buyers are crowded out of the market.

Suggested Citation

  • Herweg, Fabian & Müller, Daniel, 2011. "Overconfidence in the Market for Lemons," Discussion Papers in Economics 12411, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenec:12411
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    References listed on IDEAS

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    13. Adriani, Fabrizio & Deidda, Luca G., 2009. "Price signaling and the strategic benefits of price rigidities," Games and Economic Behavior, Elsevier, vol. 67(2), pages 335-350, November.
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    Cited by:

    1. Martin Obschonka & Moren Levesque, 2024. "A Market for Lemons? Strategic Directions for a Vigilant Application of Artificial Intelligence in Entrepreneurship Research," Papers 2409.08890, arXiv.org.
    2. Jiayu Huang & Yifan Wang & Yaojun Fan & Hexuan Li, 2022. "Gauging the effect of investor overconfidence on trading volume from the perspective of the relationship between lagged stock returns and current trading volume," International Finance, Wiley Blackwell, vol. 25(1), pages 103-123, April.

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    More about this item

    Keywords

    Adverse Selection; Market for Lemons; Overconfidence;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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