ADVERSE SELECTION WITH HETEROGENEOUSLY INFORMED AGENTS
Seyed Mohammadreza Davoodalhosseini
International Economic Review, 2020, vol. 61, issue 3, 1307-1358
A model of over‐the‐counter markets is proposed. Some asset buyers are informed in that they can identify high‐quality assets. Sellers with private information choose what type of buyers they want to trade with. When the measure of informed buyers is low, a unique equilibrium exists, and interestingly, price, trading volume and welfare typically decrease with more informed buyers. When the measure of informed buyers is intermediate, multiple equilibria arise. A switch from one equilibrium to another can lead to large drops in liquidity, price, trading volume, and welfare, like a financial crisis. Implications of an endogenous measure of informed buyers are also studied.
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