Sentiment, Liquidity and Asset Prices

Vladimir Asriyan William Fuchs   Brett Green   - Oct 17, 2017

We study a dynamic market for durable assets, in which asset owners are privately informed about the quality of their assets and experience occasional productivity shocks that generate to gains from trade. An important feature of our environment is that asset buyers must worry not only about the quality of assets they are buying, but also about the prices at which they can re-sell the assets in the future. We show that this interaction between adverse selection and resale concerns generates an inter-temporal coordination problem and gives rise to multiple self-fulfilling equilibria. We find that there is a rich set of sentiment driven equilibria, in which sunspots generate fluctuations in asset prices, market liquidity, output and welfare, resembling what one may refer to as ''bubbles.''