Editing Adverse selection (section)

=== Contract theory ===
{{main|Principal–agent problem}}
In modern [[contract theory]], "adverse selection" characterizes principal-agent models in which an agent has [[private information]] ''before'' a contract is written.<ref>{{Cite book|title = The theory of incentives: The principal-agent model|last1 = Laffont|first1 = Jean Jacques|publisher = Princeton University Press|year = 2002|last2 = Martimort|first2 = David}}</ref><ref>{{Cite book|title = Contract theory|last1 = Bolton|first1 = Patrick|publisher = MIT Press|year = 2005|last2 = Dewatripont|first2 = Matthias}}</ref> For example, a worker may know his effort costs (or a buyer may know his willingness-to-pay) ''before'' an employer (or a seller) makes a contract offer. In contrast, "[[moral hazard]]" characterizes principal-agent models where there is symmetric information at the time of contracting. The agent may become privately informed ''after'' the contract is written. According to Hart and Holmström (1987), moral hazard models are further subdivided into hidden action and hidden information models, depending on whether the agent becomes privately informed due to an unobservable action that he himself chooses or due to a random move by nature.<ref>{{cite book |last1=Hart |first1=Oliver |last2=Holmström |first2=Bengt |chapter=The theory of contracts |pages=71–155 |chapter-url=https://books.google.com/books?id=8os5AAAAIAAJ&pg=PA71 |editor1-last=Bewley |editor1-first=Truman F. |title=Advances in Economic Theory: Fifth World Congress |date=1989 |publisher=CUP Archive |isbn=978-0-521-38925-9 }}</ref> Hence, the difference between an adverse selection model and a hidden information (sometimes called hidden knowledge) model is simply the timing. In the former case, the agent is informed at the outset. In the latter case, he becomes privately informed after the contract has been signed.

In most adverse selection models, it is assumed that the agent's private information is "soft" (i.e., the information cannot be certified). Yet, there are also some adverse selection models with "hard" information (i.e., the agent may have evidence to prove that claims he makes about his type are true).<ref>{{cite journal |last1=Schmitz |first1=Patrick W. |title=Contracting under adverse selection: Certifiable vs. uncertifiable information |journal=Journal of Economic Behavior & Organization |date=February 2021 |volume=182 |pages=100–112 |doi=10.1016/j.jebo.2020.11.038 |doi-access=free |url=https://mpra.ub.uni-muenchen.de/105106/1/MPRA_paper_105106.pdf }}</ref>

Adverse selection models can be further categorized into models with private values and models with interdependent or common values. In models with private values, the agent's type has a direct influence on his own preferences. For example, he has knowledge over his effort costs or his willingness-to-pay. Alternatively, models with interdependent or common values occur when the agent's type has a direct influence on the principal's preferences. For instance, the agent may be a seller who privately knows the quality of a car.

Seminal contributions to private value models have been made by [[Roger Myerson]] and [[Eric Maskin]], while interdependent or common value models have first been studied by [[George Akerlof]]. Adverse selection models with private values can also be further categorized by distinguishing between models with one-sided private information and two-sided private information. The most prominent result in the latter case is the [[Myerson–Satterthwaite theorem|Myerson-Satterthwaite theorem]].<ref>{{cite journal |last1=Myerson |first1=Roger B |last2=Satterthwaite |first2=Mark A |title=Efficient mechanisms for bilateral trading |journal=Journal of Economic Theory |date=April 1983 |volume=29 |issue=2 |pages=265–281 |doi=10.1016/0022-0531(83)90048-0 |hdl=10419/220829 |url=http://www.kellogg.northwestern.edu/research/math/papers/469.pdf |hdl-access=free }}</ref> More recently, contract-theoretic adverse selection models have been tested both in laboratory experiments and in the field.<ref>{{Cite journal|title = Do sellers offer menus of contracts to separate buyer types? An experimental test of adverse selection theory|journal = Games and Economic Behavior|date = 2015|pages = 17–33|volume = 89|doi = 10.1016/j.geb.2014.11.001|first1 = Eva I.|last1 = Hoppe|first2 = Patrick W.|last2 = Schmitz|doi-access = free}}</ref><ref>{{Cite SSRN |title = Testing Contract Theory: A Survey of Some Recent Work|ssrn = 318780|date = 2002 |first1 = Pierre-Andre|last1 = Chiappori|first2 = Bernard|last2 = Salanie}}</ref>