Payments and liquidity under adverse selection

Informational asymmetries regarding the future value of assets affect their role in exchange. I construct a random-matching economy composed of two assets: a risk-free bond and a Lucas tree whose terminal value is privately known to its holder. No restrictions are imposed on payment arrangements. The main finding supports a pecking-order theory of payments: Agents use their risk-free bonds first in order to finance their spending shocks, and they use their information-sensitive assets only if their holdings of bonds are depleted. The theory has implications for the optimal provision of risk-free bonds, the structure of asset returns, and liquidity.