Adverse Selection in a Hostile Environment

Montserrat Cachero (European University Institute)

Abstract: This paper is aimed at analysing the screening process in a case of extreme asymmetric information: 16th century Atlantic Trade. This historical framework was featured by new maritime routes, an unexplored territory, long distances and difficulties in communications. The conventional wisdom in Economic History relies in reputation and personal links as solutions for the adverse selection problem. By contrast, this paper argues that traders used written contracts to screen among low and high risk customers. With a data set of hand-collected original contracts the paper tests whether increments in collateral requirements and in the contracts’ provisions in general attracted high risk debtors. Results show an adverse selection effect since suspicious individuals are willing to accept higher requirements.

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