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Title: Efficient Lemons

Author(s): Burak Uras and Wolf Wagner

Publication Date: January 2017

Keyword(s): Adverse Selection, cash-in-the-market pricing, opacity and underinvestment

Programme Area(s): Financial Economics

Abstract: We show that asset opacity can improve the efficiency of investment in the economy. We consider a model where underinvestment arises from speculative cash-hoardings aiming to benefit from fire-sale prices. Whereas opacity provides no benefit to asset originators in the case of isolated liquidations, this is not the case when collective liquidations lead to fire-sale prices ("cash-in-the market" pricing). As cash-in-the-market prices are set to reflect shortages of liquidity and not expected asset quality, originators can sell low quality assets opportunistically. This raises the ex-ante benefit from asset origination and reduces liquidity hoarding. The model suggests that a "seemingly undesirable" feature at the asset level can improve economic efficiency, due to a general equilibrium effect.

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Bibliographic Reference

Uras, B and Wagner, W. 2017. 'Efficient Lemons'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11803