Repurchase Options in the Market for Lemons
We study repurchase options (repo contracts) in a competitive asset market with asymmetric information. Gains from trade emerge from a liquidity need, but private information about asset quality prevents the full realization of trade. We obtain a unique equilibrium, which features a pooling repo contract and full participation among borrowers. The equilibrium repo contract resolves adverse selection: the embedded repurchase option prevents the market unraveling that occurs in asset-sale markets. However, the contract is inefficient due to cream skimming. Competition to attract high-quality borrowers through the terms of the repurchase option inefficiently lowers liquidity. The equilibrium contract has a closed form and is portable to many applications.
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Copy CitationSaki Bigio and Liyan Shi, "Repurchase Options in the Market for Lemons," NBER Working Paper 27732 (2020), https://doi.org/10.3386/w27732.Download Citation
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Published Versions
Saki Bigio & Liyan Shi, 2026. "Repurchase Options in the Market for Lemons," Review of Economic Studies, vol 93(4), pages 2390-2423.
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