Moldy Lemons and Market Shutdowns
Abstract: This paper studies competitive market shutdowns due to adverse selection, where sellers post nonexclusive menus of contracts. We first show that the presence of the worst type of agents (moldy lemons) causes markets to fail only if their mass is sufficiently large. We then show that a small mass of moldy lemons can lead to a large cascade of exits when buyers possess outside options. Our results suggest a parsimonious way of generating sudden market shutdowns without relying on institutional details or imposing additional structure on the model. Thus, the simple insights on the properties of market shutdowns we consider are applicable to many different markets and contexts.
File(s): File format is application/pdf https://www.federalreserve.gov/econres/feds/files/2022013pap.pdf
Part of Series: Finance and Economics Discussion Series
Publication Date: 2022-03-23