Information Asymmetry in Digital Financial Markets

Abstract

We study information asymmetry in digital financial markets such as crowdfunding and peer-topeer lending markets. In the digital financial market, one party persuades the other party to trade with it by sending a verifiable message or unverifiable message. While the message sender may exaggerate in an unverifiable message, the message receiver may not fully believe in the content of the message. We develop a single-stage signaling game to capture the interaction between the message sender and receiver. We analyze the level of adverse selection in the digital financial markets with different communication channels. We find that the level of adverse selection is the strongest in the market where the disclosure of a verifiable message is not mandatory. In this market, the message sender who exaggerates more in the unverifiable message tends to persuades the message receiver with higher probability. On the other hand, the level of adverse selection is the weakest in the market requiring a verifiable message because the message receiver interprets any unverifiable message as a cheap talk and only trusts the verifiable message. In the future, we plan to extend our model to a multiple-stage setting. We will examine if the same results will still hold under the influence of the message sender’s reputation built over time in a multiple-stage signaling game