Liquidity Freezes Under Adverse Selection

Joss Jorge, Charles M. Kahn
2014 Social Science Research Network  
This paper analyses how adverse selection prevents liquidity from flowing from liquid to illiquid firms, thus impairing the transmission mechanism of policy. Contrary to the results in the literature, simply increasing the availability of liquidity does not solve the adverse selection problem. When there are aggregate shocks, authorities face a policy dilemma if their single policy tool is to manipulate the price of liquidity. We consider alternative policies which address the problem in a * We
more » ... are grateful to Braz Camargo, Francesco Carli, and Agnese Leonello for helpful comments as well as seminar participants at the Federal Reserve
doi:10.2139/ssrn.2419170 fatcat:wrfisajwnfennjlbcyl3jz72oq