Lecture12 - 13 - agency moral hazard adverse selection

Outsideinvestorswillpriceeachprojectaccordingtotheir

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: lization of Signaling Suppose that the cost of providing a guarantee is higher for owners of bad cars than for those of good cars: Cb > Cg = 0 Think of “C” as the expected reimbursement to the buyer if the car breaks down. Assuming that good cars never break down, Cg = 0 Also assume that Cb > VH – VL: the cost of providing a guarantee when the car is bad is large Suppose that the market’s perceived valuation of the car is that it is good if a guarantee is offered, and bad if it is not. The market’s valuation for a car would then be V = VH if a guarantee is offered V = VL if a guarantee is not offered 27 Formalization of Signaling Given the market valuation above, will sellers of bad cars “mimic” sellers of good cars and offer a guarantee? And will sellers of good cars “mimic” sellers of bad cards and do not offer a guarantee? Given the market valuation, sellers of bad cars do not offer a guarantee, and the market prices their car at V L. If they do offer a guarantee which costs Cb, and the market prices it at VH, the no­ mimicking condition is: VL > VH – Cb [sellers of bad will not mimic sellers of good] Given the market valuation, sellers of good cars offer a guarantee (at zero cost), an...
View Full Document

This document was uploaded on 03/09/2014 for the course COMM 371 at The University of British Columbia.

Ask a homework question - tutors are online