This paper explores the tension between asset quality and market liquidity. I model an originator who screens assets whose cash flows are later sold in secondary markets. Screening improves asset quality but gives rise to asymmetric information, hindering trade of the asset cash flows. In the optimal mechanism (second‐best), costly retention of cash flows is essential to implement asset screening. Market allocations can feature too much or too little screening relative to second‐best, where too much screening generates inefficiently illiquid markets. Furthermore, the economy is prone to multiple equilibria. The optimal mechanism is decentralized with two tools: retention rules and transfers.

We study the problem of a seller (e.g. a bank) who is privately informed about the quality of her asset and wants to exploit gains from trade with uninformed buyers (e.g. investors) by issuing securities backed by her asset cash flows. In our setting, buyers post menus of contracts to screen the seller, but the seller cannot commit to trade with only one buyer, i.e. markets are non-exclusive. We show that non-exclusive markets behave very differently from exclusive ones: (1) separating contracts are never part of equilibrium; (2) mispricing of claims faced by the seller is always greater than in exclusive markets; (3) there is always a semi-pooling equilibrium where all sellers issue the same debt contract priced at average-valuation, and sellers of low-quality assets issue remaining cash flows at low-valuation; (4) market liquidity can be higher or lower than in exclusive markets, but (5) the average quality of originated assets is always lower. Our model’s predictions are consistent with empirical evidence on the issuance and pricing of mortgage-backed securities, and we use the theory to evaluate recent reforms aimed at enhancing transparency and exclusivity in markets.

This paper studies bank learning through repeated interactions with borrowers from a new perspective. To understand learning by lending, we adapt a methodology from labor economics to analyze how loan contract terms evolve as banks acquire new information about borrowers. We construct “proxy” variables for this information using data from borrowers’ out-of-sample, future credit performance. Due to the timing of their construction, banks could not have used these variables directly to price loans. We nonetheless find that these proxies increasingly predict loan prices as relationships progress, even after controlling for possible omitted variable bias. Our methodology provides strong evidence that: (a) bank learning affects loan prices, and (b) relationship benefits are heterogeneous. In particular, higher quality borrowers face differentially lower spreads as their relationship with lenders develop – and banks learn about their quality – while lower quality borrowers see loan prices increase and their loan amounts fall. We further find suggestive evidence that banks incorporate CEO-specific information into loan prices.

How do macrofinancial shocks affect investor behavior and market dynamics? Recent evidence on experience effects suggests a long-lasting influence of personally experienced outcomes on investor beliefs and investment but also significant differences across older and younger generations. We formalize experience-based learning in an overlapping generations (OLG) model, where different cross-cohort experiences generate persistent heterogeneity in beliefs, portfolio choices, and trade. The model allows us to characterize a novel link between investor demographics and the dependence of prices on past dividends while also generating known features of asset prices, such as excess volatility and return predictability. The model produces new implications for the cross-section of asset holdings, trade volume, and investors’ heterogeneous responses to crises, which we show to be in line with the data.

We investigate the effect of scrutiny (e.g., credit ratings, analyst reports, or mandatory disclosures) on the security design problem of a privately informed issuer. We show that scrutiny has important implications for both the form of security designed and the amount of inefficient retention of cash flows. The model predicts that issuers will design informationally sensitive securities (i.e., levered equity) when scrutiny is sufficiently intense. Otherwise, issuers opt for a standard debt contract. Scrutiny increases efficiency by decreasing issuers’ reliance on retention to signal quality and, perhaps counterintuitively, decrease price informativeness.

We show that in a canonical model with heterogeneous entrepreneurs, financial frictions, and an imperfectly elastic supply of capital, a fall in the interest rate has an ambiguous effect on aggregate economic activity. In partial equilibrium, a lower interest rate raises aggregate investment both by relaxing financial constraints and by prompting relatively less productive entrepreneurs to invest. In general equilibrium, however, this higher demand for capital raises its price and crowds out investment by more productive entrepreneurs. When this reallocation is strong enough, a fall in the interest rate reduces aggregate output. A numerical exploration of the model suggests that this reallocation effect is quantitatively significant and—in response to persistent changes in the interest rate—stronger than the traditional balance-sheet channel. We provide evidence of the reallocation effect using U.S. firm-level data.

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.”