Waiting for News in the Market for Lemons

Econometrica, Vol. 80, No. 4 (July, 2012), 1433–1504 WAITING FOR NEWS IN THE MARKET FOR LEMONS B Y B RENDAN D ALEY AND B RETT G REEN 1 We study a dynamic setting in which stochastic information (news) about the value of a privately informed seller’s asset is gradually revealed to a market of buyers. We con- struct an equilibrium that involves periods of no trade or market failure. The no-trade period ends in one of two ways: either enough good news arrives, restoring confidence and markets reopen, or bad news arrives, making buyers more pessimistic and forcing capitulation that is, a partial sell-off of low-value assets. Conditions under which the equilibrium is unique are provided. We analyze welfare and efficiency as they depend on the quality of the news. Higher quality news can lead to more inefficient outcomes. Our model encompasses settings with or without a standard static adverse selection problem—in a dynamic setting with sufficiently informative news, reservation values arise endogenously from the option to sell in the future and the two environments have the same equilibrium structure. K EYWORDS : Dynamic games, adverse selection, information economics, signaling. 1. INTRODUCTION C ONSIDER AN ENTREPRENEUR who is interested in selling her company due to liquidity constraints. Naturally, she is better informed than the market about her company’s fundamentals. She would like to sell, yet there is no reason she is forced to do so on any given day nor can she commit to delaying trade. With every passing day that she retains ownership, she gains (or loses) the day’s profit and maintains the option to sell the next day. If trade is in fact delayed, then the market may learn about the value of the firm by observing cash flows, investments, customer base, and so forth. Herein lies the key innovation of this paper: we introduce an exogenous public information process, news, into a model of such settings. We then study the implications for trading behavior, efficiency, and welfare. We model the environment as a game played in continuous time, where a risk-neutral seller faces a competitive market. There is common knowledge of gains from trade, but the seller is privately informed about the asset’s value (i.e., her type), which may be either high or low. At each point in time prior to trade, the seller receives offers from the market. If an offer is accepted, then the trade is consummated and the game ends. If all offers are rejected, then the seller consumes the type-dependent flow payoff endowed by the asset. Contemporaneously, information about the seller’s type is publicly revealed We are grateful to a co-editor and three anonymous referees for helpful comments and sug- gestions. We are greatly indebted to Jeremy Bulow, Michael Harrison, and Andrzej Skrzypacz for useful conversations, comments, and encouragement. Special thanks also to Peter DeMarzo, Johannes Horner, Ilan Kremer, Jon Levin, Paul Milgrom, Yuliy Sannikov, Bob Wilson, and sem- inar participants at Chicago, Chicago GSB, Duke, MIT, Kellogg, NYU, Penn, Stanford, Olin, Wharton, UNC, Yale, and the 7th Annual Duke/Northwestern/Texas IO Theory Conference. © 2012 The Econometric Society DOI: 10.3982/ECTA9278