Dynamic markets for lemons : performance, liquidity, and policy intervention

The inefficiency of competitive markets for lemons raises fundamental questions about market performance and the role of policy intervention. We study the performance of dynamic markets, and show that when the time horizon is finite decentralized markets perform better and high quality is more liquid than centralized ones. When frictions are small, decentralized markets become completely illiquid at all but the first and the last date. When the time horizon is infinite, decentralized markets yield the static competitive surplus, whereas centralized markets have separating equilibria that yield a greater surplus. Subsidizing low quality or taxing high quality tends to increase surplus in both decentralized and centralized markets.