American Economic Review Vol. 104 No. 7 2014
Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality
Abstract
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.
- DOI
- 10.1257/aer.104.7.1875
- Volume
- 104
- Issue
- 7
- Pages
- 1875-1908
- Language
- en
- Sources
- bibtex:phds-export.bib crossref openalex