Taste Projection in Bilateral Trade

Abstract

We analyze how taste projection—the tendency to exaggerate the similarity between one’s own tastes and those of others—affects bilateral trade under asymmetric information. With independent private values, projecting tastes reduces the well-known inefficiency identified by Myerson and Satterthwaite (1983), but does not entirely eliminate it. When the bargaining protocol follows a k-double auction, projection induces the seller to set an asking price that is strictly below the rational benchmark, while concurrently inducing the buyer to bid strictly above the rational benchmark. Both of these effects widen the gap between the bid and the ask, thereby increasing the likelihood of efficient trade. In contrast, when the good also has an uncertain common-value component, taste projection leads traders to perceive the environment as being closer to a pure common-value trade than it really is, thereby exacerbating the adverse-selection problem and reducing the likelihood of efficient trade.