Pricing Under Information Asymmetry: an Analysis of the Housing Presale Market from the New Institutional Economics Perspective

Lennon HT Choy (The University of Chicago (Visiting))

Abstract: This study sets off to test Akerlof’s lemon principle which advocates that the prices of lemons and non-lemons are identical under information asymmetry and hence adverse selection problems may arise. Empirical evidence in Hong Kong’s housing presale market, however, shows that lemons are priced 3% less than non-lemons. A game-theoretical model suggests that the sellers attempt to offer a “discount” so as to induce the buyers to flip the lemons in the secondary housing market, and hence their legal liabilities could be discharged. A constrained maximization model further proposes that the optimal level of “discount” is a function of the underlying common law principle. Under a legal institution in which the caveat venditor (or let the seller beware) principle prevails, the seller will perceive a lower probability of winning the hypothetical lawsuit hence a higher “discount” will be given away, and vice versa when the caveat emptor (or let the buyer beware) principle is applied. Nevertheless, a panel data hedonic price model reveals that the “discounts” are ostensible only and the lemons are in fact overpriced by 7% and 10% in the caveat venditor and caveat emptor institutions respectively. Although lemons tend to be overpriced more under a caveat emptor than a caveat venditor legal institution, this study finds no evidence that it is more efficient to switch from the former to the latter institution. (Funded by PolyU: G-U364)