DP11803 Efficient Lemons

Author(s): Burak Uras, Wolf Wagner
Publication Date: January 2017
Keyword(s): Adverse Selection, cash-in-the-market pricing, opacity, underinvestment
JEL(s): E44, G2, O16, O47
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11803

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.