Asset trading, news, and liquidity in markets with asymmetric information, Working paper

This paper explores the role of news in financial markets with asymmetrically-informed traders. We study a continuous-time setting in which stochastic informa-tion about a privately-informed seller’s asset is revealed gradually to a market of traders. Traders ’ time preference for money is subject to random liquidity shocks generating future incentive to trade. Equilibrium prices are determined not only by traders ’ beliefs about the fundamental value of the asset, but also by expec-tations of future liquidity in the market. The equilibrium involves periods of no trade in which liquidity dries up: assets remain in the hands of a liquidity con-strained traders despite efficient gains from trade. The no-trade period ends in one of two ways: either enough good news arrives restoring confidence and re-opening markets, or bad news arrives making buyers more pessimistic and forcing market capitulation i.e., a partial sell-off of low-value assets. The no-trade periods lead to endogenous liquidation costs. Buyer’s correctly anticipate such costs driving prices below fundamental values