In response to various comments, I’ve edited this post to change the title, clarify my fundamental thesis and some terminology choices, and provide explanations for each example. I apologize if this makes some of the existing comments confusing; for posterity, the original version is here.
The high level changes:
I changed the title from “Conditional on Getting to Trade, Your Trade Wasn’t All That Great” to “Toward a Broader Conception of Adverse Selection,” since I think the former was distracting from the substance of the piece and led to people believing I think trades cannot be positive sum. Thanks in particular to @Thomas Kwa for the gentle advice to change it.
I added in an introductory section defining adverse selection, motivating the piece, clarifying some misconceptions, and providing a roadmap for the next posts in the sequence.
I reordered the examples and added section headers. The divisions aren’t perfect, there’s overlap between them, but hopefully this adds some clarity.
Because of the reordering, some of the comments referring to examples by number might not make sense. The original numbering was:
1: The Subway Seat
2: The Juggling Contest
3: The Bedroom Allocation
4: The Thanksgiving Leftovers
5: The Wheelbarrow Auction
6: The Wheelbarrow Auction pt 2
7: The Laffy Taffys
8: The Field
9: The Parking Spot
10: MoviePass
11: Widgets Inc.
I explained each section with 1-2 sentences, and added explanations for ~all of the examples.
I added the example “Alice’s Restaurant vs Bob’s Burgers,” adapted from a comment I wrote.
I included various strategies for combating adverse selection in specific scenarios. I feel conflicted about this, since I’m worried the strategies will distract from the examples and also be redundant with a lot of the content in the second post, but I think this was the right call to help motivate why paying attention to these effects can be useful.
I changed a couple of the names
I added a few footnotes
I refuse to remove the Karl/Groucho Marx joke.
I don’t think the winner’s curse is limited to this; e.g., I think if the top five bidders win in an auction for vacation tickets (not knowing the value of the vacation package in advance), the effect still exists. It also doesn’t need to be a one time thing, or a unique good.
I don’t think the clearing price in such an auction is skewed high (if it were, you could profit in expectation by consistently selling, and this should correct the effect). I do think adverse selection concerns should enter your calculation even when submitting orders to two sided auctions like this one (e.g. any US stock market opening/closing auction), because your orders are still getting filled by the market as a whole, but I agree the dynamic does not have the directional bias of the auction I describe here.