We study resource allocation under private information when the planner cannot prevent bilateral side trading between consumers and firms. Adverse selection and side trading severely restrict feasible trades: each marginal quantity must be fairly priced given the consumer types who purchase it. The resulting social costs are twofold. First, second-best efficiency and robustness to side trading are in general irreconcilable requirements. Second, there actually exists a unique budget-feasible allocation robust to side trading, which deprives the planner from any capacity to redistribute resources between different types of consumers. We discuss the relevance of our results for insurance and financial markets.
Adverse Selection; Side Trading; Second-Best Allocations.;
- D43: Oligopoly and Other Forms of Market Imperfection
- D82: Asymmetric and Private Information • Mechanism Design
- D86: Economics of Contract: Theory
TSE Working Paper, n. 19-1017, June 2019, revised October 2019