Søren Leth-Petersen Publications

Private information on car quality means the sale price reflects the average quality of cars sold, which can be lower than the average quality in the population. This difference is the lemons penalty imposed on holders of high-quality cars. The authors estimate the evolution of the lemons penalty through an equilibrium model of car ownership with private information using Danish linked registry data on car ownership, income, and wealth. They examine the aggregate implications and distributional consequences of these penalties, finding that the penalty is largest early in ownership, declines with ownership duration, reduces transaction volumes and car turnover, and weakens the self-insurance role of cars, though the market does not collapse because income shocks induce sales.

We specify an equilibrium model of car ownership with private information where individuals sell and purchase new and second-hand cars over their life-cycle. This private information introduces a transaction cost, distorts the market and reduces the value of a car as a savings instrument. We estimate the model using Danish linked registry data on car ownership, income and wealth. The transaction cost, which we term the lemons penalty, is estimated to be 18% of the price in the first year of ownership, declining with the length of ownership. It leads to large reductions in the turnover of cars and in the probability of downgrading in the event of an adverse income shock. The size of the lemons penalty declines when uncertainty in the economy increases, as in recessions: large income shocks induce individuals to sell their cars, even if of good quality, and this reduces the lemons problem.