Dynamic trading with developing adverse selection

Abstract

We study a dynamic trading game in which the information asymmetry between the agents develops over time. A seller and potential buyers start out symmetrically uninformed about the quality of a good, but the seller becomes informed after the game begins. We show that this developing adverse selection gives rise to novel trading dynamics. In particular, if the seller's learning speed is high, the equilibrium features collapse-and-recovery behavior: Both the equilibrium price and the trade probability first drop and then increase over time. While the trade surplus monotonically decreases as the learning speed increases, the seller's surplus may change non-monotonically.