Cheap talk, fraud, and adverse selection in financial markets: Some experimental evidence

We examine communication in laboratory games with asymmetric information. S ellers know true asset qualities. Potential buyers only know the quality di stribution. Prohibiting communication, we document the degree of adverse se lection. Then we examine two alternative communication mechanisms. Under "c heap talk," each seller can announce any subset of qualities. Under "antifr aud," the subset must include the true quality. Both mechanisms improve mar ket efficiency, but very differently. Relying on sellers' frequently exagge rated claims, buyers often overpay under cheap talk. Efficiency gains come at the buyers' expense. The antifraud rule improves efficiency further and eliminates the wealth transfer from buyers to sellers.