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The Downside of Asset Screening for Market Liquidity

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  • VICTORIA VANASCO

Abstract

This paper explores the tension between asset quality and liquidity in a model where an originator exerts effort to screen assets, whose cash flows can be later sold in secondary markets. Screening improves asset quality, but introduces a problem of asymmetric information that may hinder trade. In the optimal mechanism, costly retention of cash flows is essential to implement positive effort. Market allocations can feature too-much or too-little effort relative to the second best, where over-exertion comes with inefficiently illiquid markets. When gains from trade are large, markets are prone to multiple equilibria. The optimal mechanism is decentralized with differential retention rules and transfers across markets.
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  • Victoria Vanasco, 2017. "The Downside of Asset Screening for Market Liquidity," Journal of Finance, American Finance Association, vol. 72(5), pages 1937-1982, October.
    • Handle: RePEc:bla:jfinan:v:72:y:2017:i:5:p:1937-1982
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    File URL: http://hdl.handle.net/10.1111/jofi.2017.72.issue-5
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