Signaling in Competitive Search Equilibrium: Illiquidity vs. Partial Retention

Abstract

This paper develops a simple competitive search framework to study illiquidity and partial retention of assets as signals of asset quality in markets with private information. I find that both signals are used in equilibrium. However, among sellers with relatively high quality assets, those with higher-quality assets sell marginally fewer assets but with significantly lower probability. In comparison, among sellers with relatively low quality assets, those with higher-quality assets sell significantly fewer assets but with only marginally lower probability. Building on these results, I study aggregate liquidity and quality shocks. For sellers with high-quality assets, the shocks generate larger changes in trading probability than in trading volume, while the opposite happens to sellers with low-quality assets.