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

Veronica Guerrieri and Robert Shimer

No 17876, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a dynamic equilibrium model of asset markets affected by adverse selection. There exists a unique equilibrium where better assets trade at higher prices but in less liquid markets. Sellers of high-quality assets can separate because they are more willing to accept a lower trading probability. As a result, the emergence of adverse selection generates a drop in liquidity. It may also lead to a decline in the price-dividend ratio--a fire sale--and a flight to quality. Subsidies to purchasing assets may be Pareto improving and can reverse the fire sale and flight to quality.

JEL-codes: D82 E44 G14 (search for similar items in EconPapers)
Date: 2012-03
New Economics Papers: this item is included in nep-cta
Note: AP EFG
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Citations: View citations in EconPapers (20)

Published as Veronica Guerrieri & Robert Shimer, 2014. "Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality," American Economic Review, American Economic Association, vol. 104(7), pages 1875-1908, July.

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Journal Article: Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality (2014)
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