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Competitive Equilibrium in Asset Markets with Adverse Selection

Author

Listed:
  • Robert Shimer

    (University of Chicago)

  • Veronica Guerrieri

    (University of Chicago)

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.

Suggested Citation

  • Robert Shimer & Veronica Guerrieri, 2011. "Competitive Equilibrium in Asset Markets with Adverse Selection," 2011 Meeting Papers 565, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:565
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    Cited by:

    1. Kyungmin Kim & Benjamin Lester & Braz Camargo, 2012. "Subsidizing Price Discovery," 2012 Meeting Papers 338, Society for Economic Dynamics.
    2. Jonathan Chiu & Thorsten V. Koeppl, 2016. "Trading Dynamics with Adverse Selection and Search: Market Freeze, Intervention and Recovery," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 83(3), pages 969-1000.

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