The Role of Leasing Under Adverse Selection

Posted: 25 Jan 2002

See all articles by Igal Hendel

Igal Hendel

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER)

Alessandro Lizzeri

Princeton University - Department of Economics

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Abstract

Leasing contracts are extensively used in durable goods markets. These contracts specify a rental rate and an option price at which the used good can be bought on termination of the lease. This option price cannot be controlled when the car is sold. We show that in a world in which quality is observable, this additional control variable is ineffective. Under adverse selection instead, leasing contracts affect equilibrium allocations in a way that matches observed behavior in the car market. Consistent with the data, our model predicts that leased cars have a higher turnover and that off-lease used cars are of higher quality. Moreover, the model predicts that the recent increase in leasing can be explained by the observed increase in car durability. We show that leasing contracts can improve welfare but that they are imperfect tools. We also show that a producer with market power can benefit from leasing contracts for two reasons: market segmentation and better pricing of the option. Moreover, despite the fact that lessors could structure contracts to prevent adverse selection, we show that this is not in their interest.

Suggested Citation

Hendel, Igal E. and Lizzeri, Alessandro, The Role of Leasing Under Adverse Selection. Journal of Political Economy, Vol. 110, February 2002, Available at SSRN: https://ssrn.com/abstract=295074

Igal E. Hendel (Contact Author)

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alessandro Lizzeri

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States
08544 (Fax)

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