CFDP 2197R

Durables and Lemons: Private Information and the Market for Cars

Author(s): 

Publication Date: September 2019

Revision Date: September 2020

Pages: 44

Abstract: 

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.

Keywords: Lemons penalty, Car market, Income uncertainty, Estimated life-cycle equilibrium model

JEL Classification Codes: D15, D82, E21

JEL Classification Codes: D82E21

See CFDP Version(s): CFDP 2197