Cecilia Garcia-Peñalosa: cecilia.garcia-penalosa[at]univ-amu.fr
This paper shows that lemon markets exhibit liquidity fluctuations whereby the ease to sell an asset varies endogenously over time. In the model, agents meet in a decentralized market and bargain under asymmetry of information about the quality of the asset. Liquidity increases with the average quality of the pool of sellers but the composition of the pool responds negatively to past liquidity. When this effect is strong, cyclical equilibria arise where prices and volume of trade oscillate without aggregate shocks. These fluctuations are generally inecient and call for policy interventions. When the economy is in a cycle, a revertible asset purchase program can jump-start the market and smooth out fluctuations. Finally, I show that increasing transparency in the Over The Counter market harms liquidity provision and may be undesirable.