Learning while Signaling in Markets

Abstract

Consider the case of a seller that can signal its own product quality but faces uncertainty about the cost of signaling. If signaling reveals information about its cost which can be used in future trades, how does learning affect signaling incentives and the informativeness of signals for buyers? Learning can reduce the value of signaling by introducing noisiness in the interpretation of future signaling decisions--the dynamic adverse selection effect. We construct and characterize properties of equilibria in which intermediate seller's types experiment with signaling. These experimental signaling equilibria are ranked with more experimentation leading to lower welfare.

Keywords: Signaling, learning, experimentation, adverse selection

JEL Classification: C73, D83