Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality

Veronica Guerrieri and Robert Shimer

American Economic Review, 2014, vol. 104, issue 7, 1875-1908

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.

JEL-codes: D82 G12 (search for similar items in EconPapers)
Date: 2014
Note: DOI: 10.1257/aer.104.7.1875
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Citations: View citations in EconPapers (101)

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Working Paper: Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality (2012)
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