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Section 6 concludes the paper. 22 STEVEN T. SCHWARTZ ET AL. 1. 1. Learning Objectives and Introduction The primary learning objective of this experiment is to demonstrate that, due to an absence of a credible assurance service, two parties who would mutually benefit from trade may not do so. Importantly, the conditions necessary for this undesirable result to occur are not uncommon in existing equity markets. A secondary learning objective is that students gain experience in anticipating the actions of those who possess different levels of information than their own.
This general phenomenon is referred to as adverse selection in the economics literature (Akerlof, 1970; Kreps, 1990, pp. 625–660). The instructor can use the market for initial public offerings (IPOs) to illustrate the relation between the above-described scenario and real world markets with which students may be familiar. Entrepreneurs (sellers) in the IPO market sometimes sell ownership shares in order to improve diversification or liquidity, and therefore might value the residual claims on their firms less than potential buyers.
Sellers should inspect the values written on their cards, but should not show them to any other students and should not communicate to any other student the values contained on their cards. The remaining students act as potential buyers of the asset. The instructor informs the students of the following: (1) their roles; (2) the three possible buyer value/seller value combinations found on the index cards; and (3) that each 24 STEVEN T. SCHWARTZ ET AL. combination is equally likely. The instructor tells the class how to calculate profits, as shown below.