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Repurchase Options in the Market for Lemons

Saki Bigio and Liyan Shi

No 27732, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study repurchase options (repo contracts) in a competitive asset market with asymmetric information. Gains from trade emerge from a liquidity need, but private information about asset quality prevents the full realization of trade. We obtain a unique equilibrium, which features a pooling repo contract and full participation among borrowers. The equilibrium repo contract resolves adverse selection: the embedded repurchase option prevents the market unraveling that occurs in asset-sale markets. However, the contract is inefficient due to cream skimming. Competition to attract high-quality borrowers through the terms of the repurchase option inefficiently lowers liquidity. The equilibrium contract has a closed form and is portable to many applications.

JEL-codes: D82 G23 G32 (search for similar items in EconPapers)
Date: 2020-08
New Economics Papers: this item is included in nep-cfn and nep-cta
Note: EFG ME
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Working Paper: Repurchase Options in the Market for Lemons (2021) Downloads
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