Research

This project revisits the model of adverse selection under asymmetric information with the power of the rational inattention framework. I depart from the setup of Akerlof (1970) by revising its extreme information asymmetry assumption. Instead of assuming that the Seller is fully informed and the Buyer is fully uninformed, I consider a setting in which both parties are able to gather information, but at a cost. As a result, both the Seller and the Buyer become partially informed, and the information asymmetry is the consequence of the asymmetry in their incentives and unit information costs. This enhanced framework provides new insights into the implications of incomplete information for market outcomes, efficiency and welfare. When information asymmetries occur endogenously, they do not lead to market collapse, but they do create market inefficiencies. The Buyer is better off and the Seller is worse off compared to the efficient symmetric information benchmark.

I propose a model that explains the evolution of overconfidence as being a result of the constrained utility-maximizing problem of a decision maker who is rationally inattentive to information, but at the same time biased towards more optimistic subjective beliefs. Empirical studies have shown that individuals with initially fewer skills have more confidence, but as their skill level increases, their overconfidence decreases. The phenomenon is well-known as the Dunning-Kruger effect in the psychology literature. I explain this effect by the simultaneous choice of subjective and objective information. In my model a non-materialistic utility component induces overly optimistic subjective beliefs, which are constrained by the cost of information distortion. The setup is tractable in a range of economic problems. In an application, I use this model to show why individuals with fewer initial skills are less motivated to learn than those already having a higher skill level.