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Trading dynamics in decentralized markets with adverse selection

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  • Braz Camargo
  • Benjamin Lester

Abstract

The authors study a dynamic, decentralized lemons market with one-time entry and characterize its set of non-stationary equilibria. This framework offers a theory of how a market suffering from adverse selection recovers over time endogenously; given an initial fraction of lemons, the model provides sharp predictions about how prices and the composition of assets evolve over time. Comparing economies in which the initial fraction of lemons varies, the authors study the relationship between the severity of the lemons problem and market liquidity. They use this framework to understand how asymmetric information contributed to the breakdown in trade of asset-backed securities during the recent financial crisis, and to evaluate the efficacy of one policy that was implemented in attempt to restore liquidity.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 11-36.

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Date of creation: 2011
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Handle: RePEc:fip:fedpwp:11-36

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Keywords: Liquidity (Economics) ; Trade;

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References

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Citations

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Cited by:
  1. Alvarez, Fernando & Barlevy, Gadi, 2014. "Mandatory Disclosure and Financial Contagion," Working Paper Series, Federal Reserve Bank of Chicago WP-2014-4, Federal Reserve Bank of Chicago.
  2. Veronica Guerrieri & Robert Shimer, 2012. "Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality," NBER Working Papers 17876, National Bureau of Economic Research, Inc.
  3. Shengxing Zhang, 2012. "Liquidity Misallocation in an Over-The-Counter Market," 2012 Meeting Papers, Society for Economic Dynamics 529, Society for Economic Dynamics.
  4. Dino Gerardi & Lucas Maestri, 2013. "Bargaining over a Divisible Good in the Market for Lemons," Carlo Alberto Notebooks, Collegio Carlo Alberto 312, Collegio Carlo Alberto.
  5. Lester, Benjamin, 2013. "Breaking the ice: government interventions in frozen markets," Business Review, Federal Reserve Bank of Philadelphia, Federal Reserve Bank of Philadelphia, issue Q4, pages 19-25.
  6. Kyungmin Kim & Benjamin Lester & Braz Camargo, 2012. "Subsidizing Price Discovery," 2012 Meeting Papers, Society for Economic Dynamics 338, Society for Economic Dynamics.
  7. Francesc Dilme & Fei Li, 2013. "Dynamic Education Signaling with Dropout Risk, Third Version," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 14-014, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 24 Apr 2014.
  8. Briana Chang, 2012. "Adverse Selection and Liquidity Distortion in Decentralized Markets," 2012 Meeting Papers, Society for Economic Dynamics 403, Society for Economic Dynamics.
  9. Francesc Dilme & Fei Li:, 2012. "Dynamic Education Signaling with Dropout, Second Version," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 13-048, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 03 Sep 2013.
  10. Diego Moreno & John Wooders, 2013. "Dynamic Markets for Lemons: Performance, Liquidity, and Policy Intervention," Working Paper Series, Economics Discipline Group, UTS Business School, University of Technology, Sydney 5, Economics Discipline Group, UTS Business School, University of Technology, Sydney.
  11. Christopher L. House & Yusufcan Masatlioglu, 2010. "Managing Markets for Toxic Assets," NBER Working Papers 16145, National Bureau of Economic Research, Inc.
  12. Ennio Bilancini & Leonardo Boncinelli, 2014. "Dynamic Adverse Selection and the Supply Size," Center for Economic Research (RECent), University of Modena and Reggio E., Dept. of Economics 099, University of Modena and Reggio E., Dept. of Economics.
  13. Francesc Dilme & Fei Li, 2012. "Dynamic Education Signaling with Dropout," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 12-023, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.

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