Arbitrary Bilateral Bargaining in Decentralized Markets for Lemons

Abstract

We investigate the efficiency of dynamic random matching and bilateral bargaining markets with adverse selection. We take a detail-free approach to the bargaining game, assuming only that: (a) each agent's actions are optimal given the equilibrium market conditions and the equilibrium strategy of the opposing agents; (b) bargaining reveals information about the quality of the object to the uninformed buyer, who cannot commit to acquire the object at a price that exceeds her expected reservation price conditional on such information. We characterize the equilibrium that maximizes the realized gains from trade among all decentralized equilibria. We show this equilibrium features full information revelation during bargaining. This equilibrium also realizes strictly more gains from trade than any equilibrium of trade under a price system, which we use as a benchmark for trade in centralized markets. However, as trading frictions vanish, the optimal decentralized market allocation converges to the optimal centralized market allocation.