Reputation and Adverse Selection, Theory and Evidence from eBay

Abstract

How can actors in a marketplace introduce mechanisms to overcome possible inefficiencies caused by adverse selection? Using a unique dataset that follows sellers on eBay over time, I show that reputation is a major determinant of variations in price. I develop a model of firm dynamics where firms have heterogeneous qualities unobservable by consumers. Reputation is used as a signal of private information. I structurally estimate the model to uncover buyers' utility and sellers' costs and qualities. Removing the reputation mechanism increases low-quality sellers' marketshare, lowers prices, and consequently reduces the market size by 61% and consumer surplus by 48%.