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Trading dynamics in decentralized markets with adverse selection

Braz Camargo () and Benjamin Lester ()

No 11-36, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: The authors study a dynamic, decentralized lemons market with one-time entry and characterize its set of non-stationary equilibria. This framework offers a theory of how a market suffering from adverse selection recovers over time endogenously; given an initial fraction of lemons, the model provides sharp predictions about how prices and the composition of assets evolve over time. Comparing economies in which the initial fraction of lemons varies, the authors study the relationship between the severity of the lemons problem and market liquidity. They use this framework to understand how asymmetric information contributed to the breakdown in trade of asset-backed securities during the recent financial crisis, and to evaluate the efficacy of one policy that was implemented in attempt to restore liquidity.

Keywords: Liquidity (Economics); Trade (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cta
Date: 2011
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Related works:
Journal Article: Trading dynamics in decentralized markets with adverse selection (2014) Downloads
Working Paper: Trading Dynamics in Decentralized Markets with Adverse Selection (2011) Downloads
Working Paper: Trading Dynamics in Decentralized Markets with Adverse Selection (2010) Downloads
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