Market segmentation Adverse Selection and Liquidity Distortion in

This paper studies the competitive equilibrium outcome in decentralized asset markets when both search frictions and adverse selection play a role. In a dynamic environment with heterogeneous sellers and buyers, I show how adverse selection leads to the downward distortion of equilibrium market liquidity. As our setup captures two important dimensions in the trading market, price and liquidity, it shows how price and liquidity are jointly determined as an equilibrium outcome and further sheds lights on market segmentation. The model predicts a strong link between the market liquidity and the underlying uncertainty stemming from adverse selection and provides an explanation for the existence of massive illiquidity. It further allows for a richer analysis of how sorting patterns are determined in such an environment and how di¤erent market distortion may arise when sellersmotives for sale are unknown to the market