| Abstract |
We study a model of dynamic adverse selection in which a large group
of sellers sell an asset of uncertain quality to a larger group of buyers. The
quality is known to the sellers but unknown to the buyers. There is, however,
the possibility that if the asset is of low quality, this will be revealed via public
news at a random time. We show that there is a unique equilibrium satisfying
forward induction. In this equilibrium a bubble develops. Even a worthless
asset is traded at rapidly increasing prices. This is because in the absence
of bad news, buyers become more and more optimistic - they exhibit rational
exuberance. |