Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality
We develop a dynamic equilibrium model of asset markets with adverse selection. There exists a unique equilibrium in which better quality assets trade at higher prices but with a lower price-dividend ratio in less liquid markets. Sellers of high-quality assets signal quality by accepting a lower trading probability. We show how the distribution of sellers' private information affects an asset's price and liquidity, how a change in that distribution can cause a fire sale and a flight to quality, and how asset purchase and subsidy programs may raise prices and liquidity and reverse the flight to quality.
Volume (Year): 104 (2014)
Issue (Month): 7 (July)
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- Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
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