Overconfidence in the Market for Lemons

Herweg, Fabian and Müller, Daniel (November 2011): Overconfidence in the Market for Lemons. Discussion Papers in Economics 2011-17

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.

• Item Type: Paper
• Keywords: Adverse Selection, Market for Lemons, Overconfidence
• Faculties: Economics; Economics > Munich Discussion Papers in Economics
• Subjects: 300 Social sciences > 300 Social sciences, sociology and anthropology; 300 Social sciences > 330 Economics
• JEL Classification: D82, L15
• Language: English

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