Efficient Sorting in a Dynamic Adverse Selection Model: The Hot Potato

Abstract

We study the possibility of achieving efficiency in a dynamic adverse selection market for durable goods. The idea is to use the number of times a car has been traded (``vintage'') as a signal of its quality. Higher-valuation consumers experiment with younger vintages. We first exhibit an impossibility result: no choice of (re)sale prices can induce consumers to follow this experimentation policy. We then show that modified leasing contracts can be constructed so as to achieve efficiency if consumers are patient.