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Ratings, Certifications and Grades: Dynamic Signaling and Market Breakdown

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Skrzypacz, Andrzej (Stanford U)
Kremer, Ilan

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Abstract

We consider the effect a public revelation of information (e.g. rating, grade) has on signaling and trading in a dynamic model. Competing buyers offer prices to a privately informed seller who can reject these offers and delay trade. This delay is costly and the seller has no commitment to the duration of the delay. We show how the external public information allows for signaling in equilibrium. More interestingly, we characterize the dynamics of trade and prices. If the signal is not fully revealing, then there is no trade just before the revelation of external information. A lemons market develops endogenously over time and prevents any trade close to the release of the public announcement. On the other hand, if the external signal is fully revealing, then trade occurs even close to the final period; however, in this case there is a discontinuity in prices.

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Paper provided by Stanford University, Graduate School of Business in its series Research Papers with number 1814r2.

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Date of creation: May 2005
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Handle: RePEc:ecl:stabus:1814r2

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C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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  1. Admati, Anat R & Perry, Motty, 1987. "Strategic Delay in Bargaining," Review of Economic Studies, Blackwell Publishing, vol. 54(3), pages 345-64, July. [Downloadable!] (restricted)
  2. Swinkels, Jeroen M, 1999. "Education Signalling with Preemptive Offers," Review of Economic Studies, Blackwell Publishing, vol. 66(4), pages 949-70, October. [Downloadable!] (restricted)
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  3. Weiss, Andrew, 1983. "A Sorting-cum-Learning Model of Education," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 420-42, June. [Downloadable!] (restricted)
  4. Korajczyk, Robert A. & Lucas, Deborah J. & McDonald, Robert L., 1992. "Equity Issues with Time-Varying Asymmetric Information," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 397-417, September. [Downloadable!]
  5. Banks, Jeffrey S. & Sobel, Joel., 1985. "Equilibrium Selection in Signaling Games," Working Papers 565, California Institute of Technology, Division of the Humanities and Social Sciences. [Downloadable!]
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  6. Nick Feltovich & Richmond Harbaugh & Ted To, 2002. "Too Cool for School? Signalling and Countersignalling," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 630-649, Winter.
  7. Noldeke, Georg & van Damme, Eric, 1990. "Signalling in a Dynamic Labour Market," Review of Economic Studies, Blackwell Publishing, vol. 57(1), pages 1-23, January. [Downloadable!] (restricted)
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  8. Korajczyk, Robert A & Lucas, Deborah J & McDonald, Robert L, 1991. "The Effect of Information Releases on the Pricing and Timing of Equity Issues," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 4(4), pages 685-708. [Downloadable!] (restricted)
  9. Kohlberg, Elon & Mertens, Jean-Francois, 1986. "On the Strategic Stability of Equilibria," Econometrica, Econometric Society, vol. 54(5), pages 1003-37, September. [Downloadable!] (restricted)
  10. Teoh, Siew Hong & Hwang, Chuan Yang, 1991. "Nondisclosure and Adverse Disclosure as Signals of Firm Value," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 4(2), pages 283-313. [Downloadable!] (restricted)
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