Endogenous Lemons Markets and Information Cycles

I study a dynamic stochastic general equilibrium model in which information on capital quality is asymmetric and the degree of information asymmetry varies endogenously with the state of the economy, amplifying the shocks. Firms hold capital and borrow to cover their operating expenses. Production is subject to idiosyncratic shocks. When a firm's realized revenue is not enough to cover its debt obligation, that firm has to liquidate capital in a market that is subject to the lemons problem. During production, some of the firm's capital depreciates and becomes ``lemon''. Firms initially have no information on which units of their capital have depreciated, but can acquire private information on their own capital at a cost, which allows them to select low-quality capital to sell when liquidation takes place. Private information can be individually beneficial, but creates the lemons problem, which decreases market liquidity and distorts economic allocations. Adverse shocks trigger additional private information acquisition, exacerbating the lemons problem. The model can account for the business cycle patterns in the U.S., and in particular, the sizable fluctuations of capital reallocation