Brett S. Green

Waiting for News in the Market for Lemons

We study a dynamic setting in which stochastic information about the value of a privately-informed seller’s asset is gradually revealed to a market of buyers. We characterize the unique equilibrium in a continuous-time framework. The equilibrium involves periods of no trade or market failure. The no-trade period ends in one of two ways: either enough good news arrives restoring confidence and markets re-open, or bad news arrives making buyers more pessimistic forcing market capitulation i.e., a partial sell-off of low-value assets. Reservation values arise endogenously from the option to sell in the future. Our model encompasses both lemons and signaling environments - in a dynamic setting with sufficiently informative news, the two environments have the same equilibrium structure.

Market Signaling with Grades

We consider a signaling model in which receivers observe both the senders costly signal as well as a stochastic grade that is correlated with the senders type. In equilibrium, the sender resolves the trade-off between using the costly signal versus relying on the noisy grade to distinguish himself. We derive a necessary and sufficient condition—loosely, that the grade is sufficiently informative relative to the dispersion of (marginal) signaling costs across types—under which the presence of grades substantively alters the equilibrium predictions. Specifically, separating equilibria do not survive stability-based refinements. Instead, the prediction depends on the prior distribution over the senders type. For example, with two types it involves full pooling when the distribution places sufficient weight on the high type and partial pooling otherwise. Finally, the equilibrium converges to the complete-information outcome as the distribution tends to a degenerate one—resolving a long-standing paradox within the signaling literature.

Signal or Noise? Uncertainty and Learning about Whether Other Traders are Informed

We develop a model where some investors are uncertain whether others are trading on informative signals or noise. Uncertainty about others leads to a nonlinear price that reacts asymmetrically to news. We incorporate this uncertainty into a dynamic setting where traders gradually learn about others and show that it generates empirically relevant return dynamics: expected returns are stochastic but predictable, and volatility exhibits clustering and the “leverage” effect. The model nests both the rational expectations (RE) and differences of opinions (DO) approaches and highlights a link between disagreement about fundamentals and uncertainty about other traders.In standard rational expectations models, investors know whether others are informed, and therefore know how to update their beliefs using prices. We develop a dynamic model in which investors must learn whether others are informed and, therefore, learn how to use the information in prices. We show that the price is a non-linear function of the underlying signal, and expected returns and volatility are stochastic and persistent, even though shocks to fundamentals and signals are i.i.d. The price reaction to information about dividends is asymmetric: the price reacts more strongly to bad news than it does to good news. The model also generates volatility clustering in which large return realizations, which are associated with dividend surprises, are followed by higher volatility and higher expected returns.

Information Spillovers in Asset Markets with Correlated Values

We study information spillovers in a dynamic setting with privately informed traders and correlated asset values. A trade of one asset (or lack thereof) can provide information about the value of other assets. The information content of trading behavior is endogenously determined in equilibrium. We show that this endogeneity leads to multiple equilibria when the correlation between asset values is sufficiently high. The equilibria are ranked in terms of both trade volume and efficiency. We study the implications for policies that target market transparency as well as the markets ability to aggregate information. Total welfare is higher in any equilibrium of a fully transparent market than in a fully opaque one. However, both welfare and trading activity can decrease in the degree of market transparency. If traders have asymmetric access to transaction data, transparency levels the playing field, reduces the rents of more informed traders, but may also reduce total welfare. Moreover, even in a fully transparent market, information is not necessarily aggregated as the number of informed traders becomes arbitrarily large.

Breakthroughs, Deadlines, and Self-Reported Progress: Contracting for Multistage Projects

We study the optimal incentive scheme for a multistage project in which the agent privately observes intermediate progress. The optimal contract involves a soft deadline wherein the principal guarantees funding up to a certain date – if the agent reports progress at that date, then the principal gives him a relatively short hard deadline to complete the project – if progress is not reported at that date, then a probationary phase begins in which the project is randomly terminated at a constant rate until progress is reported. Self-reported progress plays a crucial (but non-stationary) role in implementation. We explore several variants of the model with implications for optimal project design. In particular, we show that the principal benefits by imposing a small cost on the agent in order to submit a progress report or by making the first stage of the project somewhat “harder” than the second. On the other hand, the principal does strictly worse by impairing the agent’s ability to observe his own progress. JEL Classification: J41, L14, M55, D82

Bargaining and News

We study a bargaining model in which a buyer makes frequent offers to a privately informed seller, while gradually learning about the seller’s type from “news.�? We show that the buyer’s ability to leverage this information to extract more surplus from the seller is remarkably limited. In fact, the buyer gains nothing from the ability to negotiate a better price despite the fact that a negotiation must take place in equilibrium. During the negotiation, the buyer engages in a form of costly “experimentation�? by making offers that are sure to earn her negative payoffs if accepted, but speed up learning and improve her continuation payoff if rejected. We investigate the effects of market power by comparing our results to a setting with competitive buyers. Both efficiency and the seller’s payoff can decrease by introducing competition among buyers.

Securitization, Ratings, and Credit Supply

We develop a framework to explore the effect of credit ratings on loan origination and securitization. In the model, banks privately screen and originate loans and then issue securities that are backed by loan cash flows. Issued securities are rated and sold to investors. Without ratings, banks with good loans retain a portion of them to signal quality to investors. With informative ratings, banks rely less on costly retention and more on public information. Moreover, when ratings are sufficiently accurate, banks may eschew retention altogether and simply originate to distribute (OTD). Thus, ratings endogenously shift the economy from a Signaling equilibrium with inefficient retention towards an OTD equilibrium with inefficiently low lending standards. Ratings therefore increase overall efficiency provided the reduction in costly retention more than compensates for the origination of some negative NPV loans. We study how banks ability to screen loans affects these predictions, and use the model to analyze commonly proposed policies such as mandatory “skin in the game.�?

Information Aggregation in Dynamic Markets with Adverse Selection

How effectively does a decentralized marketplace aggregate information that is dis-persed throughout the economy? We study this question in a dynamic setting, in which sellers have private information that is correlated with an unobservable aggregate state. We first characterize equilibria with an arbitrary (but finite) number of informed sellers. A common feature is that each seller’s trading behavior provides an informative and con-ditionally independent signal about the aggregate state. We then ask whether the state is revealed as the number of informed sellers goes to infinity. Perhaps surprisingly, the answer is no. We provide conditions under which the amount of information revealed is necessarily bounded and does not reveal the aggregate state. When these conditions are violated, there may be coexistence of equilibria that lead to full revelation with those that do not. We discuss the implications for policies meant to enhance information dissemination in markets.How effectively does a decentralized marketplace aggregate information that is dispersed throughout the economy? We study this question in a dynamic setting where sellers have private information that is correlated with an unobservable aggregate state. In any equilibrium, each seller’s trading behavior provides an informative and conditionally independent signal about the aggregate state. We ask whether the state is revealed as the number of informed traders grows large. Surprisingly, the answer is no; we provide conditions under which information aggregation necessarily fails. In another region of the parameter space, aggregating and non-aggregating equilibria coexist. We solve for the optimal information policy of a constrained social planner who observes trading behavior and chooses what information to reveal. We show that non-aggregating equilibria are always constrained inefficient. The optimal information policy Pareto improves upon the laissez-faire outcome by concealing information about trading volume when it is sufficiently high.

Optimal Arrangements for Distribution in Developing Markets: Theory and Evidence

A large literature examines demand-side barriers to product adoption. In this paper, we examine supply-side barriers in a setting with limited contract enforcement. We model the relationship between a distributor and its credit-constrained vendors. We show that the optimal self-enforcing arrangement can be implemented by providing vendors with a line of credit and the option to buy additional units at a fixed price. Moreover, the structure of this arrangement is optimal both for profit-maximizing firms and for non-profit organizations with limited resources. We test the arrangement using a field experiment in rural Uganda. We find that the model-implied optimal arrangement increased distribution significantly compared to a standard contract. However, growth was lower than predicted by the model because vendors (i) were unwilling to extend credit to customers, and (ii) did not have access to a reliable savings technology. We discuss several recent technological innovations that help to overcome both of these challenges.

Security Design with Ratings

We investigate the effect of public information, such as ratings, on the security design problem of a privately informed issuer. We show that the presence of ratings has important implications for both the form of security designed and the amount of inefficient retention. The model predicts that issuers will design informationally sensitive securities (i.e., levered equity) when ratings are sufficiently informative relative to the gains from trade. Otherwise, issuers opt for a standard debt contract. In either case, informative ratings increase market liquidity by decreasing the reliance on inefficient retention to convey high quality, and perhaps counterintuitively, decrease price informativeness.