Adverse selection in the cattle procurement market

This study tests for adverse selection using data from a feedlot in Oklahoma by analyzing the distribution of cattle quality between alternative marketing arrangements and cash markets. Unlike previous studies employing Heckman and Roy models to detect adverse selection, this study directly examines the empirical distributions of cattle quality variables derived from heteroskedastic probit, residual, truncated, and generalized least squares regressions. Nonparametric procedures are used to identify differences in the empirical distribution functions of quality variables between the two markets. The empirical distribution functions of cattle quality suggest that the distribution of cattle quality in the AMA market stochastically dominates that in the cash market. The null hypothesis that cattle quality in the AMA and cash markets comes from the same continuous distribution was rejected at the 1% level. The results provide strong evidence of adverse selection in cattle procurement for the analyzed dataset. Initiatives promoting greater disclosure of quality-related information for cattle sold in the cash market are recommended to mitigate this issue.