Asymmetric information and adverse selection

This paper develops a framework for the analysis of how asymmetric information impacts on adverse selection and market efficiency. We adopt Akerlof's (1970) unit-demand model extended to a setting with multidimensional public and private information. Adverse selection and efficiency are defined quantitatively as real valued random variables. We characterize how public information disclosure and private information acquisition affect the relationship between adverse selection and efficiency. These results are applied to inform welfare and empirical analysis and, in an employer learning setting, to study the endogenous choice of information structures. Equilibrium information structures impose adverse selection efficiently. We show that this makes adverse selection hard to detect using standard positive correlation tests.