Competitive Equilibrium in Asset Markets with Adverse Selection

Robert Shimer and Veronica Guerrieri
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Veronica Guerrieri: University of Chicago

No 565, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: We develop a theory of equilibrium in asset markets with adverse selection. Traders can buy and sell an asset at any price. Sellers recognize that their trades may be rationed if they ask for a high price, while buyers recognize that they can only get a high quality good by paying a high price. These beliefs are consistent with rational behavior by the traders on the other side of the market. In the resulting equilibrium, the existence of low-quality assets reduces the liquidity and price-dividend ratio in the market for high quality assets. A larger player who purchases and destroys all the low quality assets will improve the liquidity and raise the price-dividend ratio for the remaining assets.

Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed011:565

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