Abstract
How can fire sales for financial assets happen when the economy contains well-capitalized, but non-specialist investors? Our explanation combines rational expectations equilibrium and lemons models. When specialist (informed) market participants are liquidity-constrained, prices become less informative. This creates an adverse selection problem, decreasing the supply of high-quality assets, and lowering valuations by non-specialist (uninformed) investors, who become unwilling to supply capital to support the price. Arbitrage capital can multiply itself by making uninformed capital function as informed capital in normal times, but this stabilizing mechanism fails during a crisis.
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