We propose an information‐based theory to explain time variation in liquidity and link it to a variety of patterns in asset markets. In “normal times,” the market is fully liquid and gains from trade are realized immediately. However, the equilibrium also involves periods during which liquidity “dries up,” which leads to endogenous liquidation costs. Traders correctly anticipate such costs, which reduces their willingness to pay. This foresight leads to a novel feedback effect between prices and market liquidity, which are jointly determined in equilibrium. The model also predicts that contagious sell‐offs can occur after sufficiently bad news.

We propose a model of due diligence and analyze its effect on prices, payoffs, and deal completion. In our model, if the seller accepts an offer, the winning bidder (or “acquirer”) can gather information and chooses when to complete the transaction. In equilibrium, the acquirer engages in “too much” due diligence. Our quantitative results suggest that the magnitude of the distortion is economically significant. Nevertheless, allowing for due diligence can improve both total surplus and the seller's payoff compared to a setting without due diligence. We use our framework to explore the timing of due diligence, bidder heterogeneity, and breakup fees.

We develop a framework to explore the effect of credit ratings on loan origination. We show that ratings endogenously shift the economy from a signaling equilibrium, in which banks inefficiently retain loans to signal quality, toward an originate‐to‐distribute equilibrium with zero retention and inefficiently low lending standards. Ratings increase overall efficiency, provided that the reduction in costly retention more than compensates for the origination of some negative net present value loans. We study how banks' ability to screen loans affects these predictions and use the model to analyze commonly proposed policies such as mandatory “skin in the game.”