Dynamic trading with developing adverse selection

A Theory of Zombie Lending

“…Our core mechanism shares similarities with Hwang (2018). On the specific results of equilibrium in the last two regions, the difference is a matter of equilibrium selection, which lies between pure strategies and mixed strategies.…”

“…Broadly, our paper is related to three stands of literature. We build on the approach of dynamic signaling and private learning (Janssen and Roy (2002), Kremer and Skrzypacz (2007), Daley and Green (2012), Fuchs and Skrzypacz (2015), Grenadier, Malenko, and Strebulaev (2014), Atkeson, Hellwig, and Ordoñez (2014), Marinovic and Varas (2016), Martel, Mirkin, and Waters (2018), Hwang (2018), Kaniel and Orlov (2020)). In our model, news is private, whereas in Daley and Green (2012), news is publicly observable.…”

“…In our model, news is private, whereas in Daley and Green (2012), news is publicly observable. Martel, Mirkin, and Waters (2018) and Hwang (2018) also study problems in which sellers become gradually informed about an asset's quality. Besides the specific application to relationship banking, our model has different theoretical implications.…”

“…This assumption imposes restrictions so that at least some level of bank financing will be used in the first‐best benchmark. Equation (12) is the static lemons condition in the literature (Daley and Green (2012), Hwang (2018)), which requires that the price of a bad‐type bond be lower than the value of a good‐type loan. Given Assumption 1, (13) essentially requires that be sufficiently high that the private news produced during bank financing is sufficiently useful.…”

Intermediaries and product quality in used car markets

“…When a buyer and a seller meet in the unmediated market, the buyer observes neither the quality of the car nor whether the seller has visited a dealer. Notice that the information asymmetry between the seller and buyers is developing over time: as the car ages, the public prior belief declines, with as t → ∞, q t → 0; see Hwang (2018) for a more detailed discussion of developing asymmetric information.…”