Yamashita, Takuro and Murooka, Takeshi (2022) Adverse selection and bounded rationality: an impossibility theorem. The Japanese Economic Review.

Abstract

We consider an adverse selection environment between an informed seller and an uninformed buyer, where no trade occurs when all buyers are the standard Bayesian-rational type. The buyer may be a “behavioral” type in that he may take actions different from the rational type. We show that, for any incentive-feasible mechanism with any non-trivial trade, the buyer’s ex-ante expected payoff is strictly negative. Our result implies that whenever trade occurs, some behavioral types must incur losses—highlighting a new trade-off between social surplus and buyer protection.