Adverse Selection and the Market for Free Agents in Major League Baseball

Abstract

In his paper, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” George Akerlof (1970) analyzes the effect of information asymmetry between buyers and sellers in various markets. Akerlof argues that sellers in a market characterized by asymmetric information keep their highest quality goods to themselves and market only the goods of lower quality (which he refers to as the "lemons"). In my thesis, I test for the presence of asymmetric information and quality uncertainty in the free agency market of Major League Baseball. My hypothesis is that baseball teams have private information about their own players that give them a more precise estimate of their players’ future performance in comparison to other teams in the league. If we think of a player’s original team as the potential “seller” of that player, then the team will be more inclined to allow another team to “buy” that player in the open free agency market if it possesses negative (private) information that lowers its expectation of the player’s future performance relative to what the rest of the market believes. Therefore, I hypothesize that the players that are not signed by their original team and instead sign with a new team in free agency are the “lemons” that result from adverse selection in the MLB free agency market. With my baseline model, I test my hypothesis by comparing the ex-post performance of players that change teams in free agency with that of players that return to their previous teams.