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The classic literature refers to the problem where information asymmetry exists between an informed and an uninformed counterpart as the adverse selection problem, but how can we verify what kind of such a game is? Namely, how can we know that such a game is a screening game or a signaling one?

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Signaling is the informed side taking actions to reduce (or maintain, depending on the private types) the information asymmetry. For example, high skill workers getting certifications to signal their productivity so as earn a higher wage. Or low skill workers trying to mimic the high-skilled's behavior as much as possible so that they cannot be separated.

Screening is the uninformed side taking actions to reduce the information asymmetry. For example, monopolists use price discrimination strategies to identify customers with high vs low willingness to pay and charge them accordingly.

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  • $\begingroup$ Hmm, i.e. a broker, or a market maker or an intermediary in general, who is a monopolist in some OTC market, to make the matching in a bilateral trade, she needs to screen the parties, to know their types. She does so, because she knows that if she wants to make profits, she has to control the problem and designate the kind of investors, am I right? $\endgroup$ – Nav89 Sep 26 at 21:28
  • $\begingroup$ @Nav89: I'm not sure I follow your example completely. But that a broker who wants to bring together a potential buyer and a potential seller should screen the types of them sounds like a right application of a screening game. $\endgroup$ – Herr K. Sep 27 at 2:27
  • $\begingroup$ Hence, in order to do so, we need the constraints for indivifual rationality and incentive compatibility. For every type of investor we have two constraitns, an \textbf{IR} constraint and an \textbf{IC} constraint, which means we have four constraints in total. Some of these constraints are binding and some others are redundant. I thinke this is how the whole story goes... $\endgroup$ – Nav89 Sep 27 at 4:59
  • $\begingroup$ @Nav89: Sounds like you're on the right track. $\endgroup$ – Herr K. Sep 27 at 5:01
  • $\begingroup$ Than you very much! It is very important to know the intuition behind these problems more than solving the maths, which sometimes can be extremely hordcore :) $\endgroup$ – Nav89 Sep 27 at 5:09

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