An important change in the automobile market over the last few decades has been the substantial growth in new-car leasing. Building on recent theoretical research, we construct a model of the leasing decision in which leasing mitigates adverse selection and reduces transaction costs, but moral hazard limits its use. Also, in our model the prevalence of leasing is related to new-car reliability, so it suggests that the growth in leasing over time is at least partly due to improvements over time in new-car reliability. We use this model to derive a number of testable implications and then conduct an empirical analysis of the new-car and used-car markets to investigate whether the operation of these markets is consistent with the predictions of this theoretical approach. Our empirical results support the theoretical predictions of our model. In particular, we provide the first direct evidence that leasing serves to mitigate adverse selection and our results also indicate that an important factor in the growth in new-car leasing has indeed been the growth in new-car reliability.
Available at: http://works.bepress.com/henry_schneider/5/