Dealing with Uncertainty: The Value of Reputation in the Absence of Legal Institutions

TL;DR

This study examines how reputation influences online illegal drug markets lacking legal enforcement, showing that ratings significantly impact prices and seller earnings, with reputation effects recovering over time after platform disruptions.

Contribution

It provides empirical evidence on the role of reputation in illegal online markets and quantifies its impact on prices and seller earnings after platform shocks.

Findings

Prices decrease by up to 9% after platform disappearance

A 1% increase in rating leads to a 1% price increase

Reputation and prices recover within three months

Abstract

This paper studies reputation in the online market for illegal drugs in which no legal institutions exist to alleviate uncertainty. Trade takes place on platforms that offer rating systems for sellers, thereby providing an observable measure of reputation. The analysis exploits the fact that one of the two dominant platforms unexpectedly disappeared. Re-entering sellers reset their rating. The results show that on average prices decreased by up to 9% and that a 1% increase in rating causes a price increase of 1%. Ratings and prices recover after about three months. We calculate that identified good types earn 1,650 USD more per week.