Durables and Lemons: Private Information and the Market for Cars

We examine the aggregate implications and distributional consequences of asymmetric information in durable goods markets, with a focus on the car market. Private information introduces a lemons penalty, a wedge between the sale price and the average car value in the population, consequently reducing turnover. We estimate an equilibrium model of car ownership with private information using Danish linked registry data on car ownership, income, and wealth. In the first year of ownership, we estimate the lemons penalty is 12% of the price. The penalty declines sharply with the length of ownership. The penalty reduces the self-insurance value of cars and leads to a large reduction in transaction volumes and the rate of turnover of cars. The market does not collapse: income shocks induce individuals to sell their cars, even if they are of good quality, and this helps mitigate the lemons problem. The size of the lemons penalty declines when income uncertainty in the economy increases and when the credit limit decreases.