Faculty of Economics and Business Administration Publications Database

Matching Markets with Adverse Selection

Volume: 121
Number: 2
Pages: 145 - 166
Month: April
ISSN-Print: 0022-0531
Link External Source: Online Version
Year: 2005
Keywords: Adverse selection; Screening; Matching markets
Abstract: This paper considers a market with adverse selection in the spirit of Rothschild and Stiglitz (Quart. J. Econ. 90 (1976) 629). The major departure from existing approaches is that we model a decentralized market that is open-ended and constantly refilled by new participants, e.g., by new workers and firms in the case of a labor market. The major novelty of this approach is that the distribution of types in the market becomes an endogenous variable, which is jointly determined with equilibrium contracts. As frictions become small, we show that the least-cost separating contracts are always supported as an equilibrium outcome, regardless of the distribution of types among entrants. Moreover, we derive conditions under which this outcome is also unique.