This paper introduces reputation building in directed search with adverse selection. Seller types randomly determine the quality of the asset they hold, where both a seller`s type and asset quality are private information. When an exchange occurs, the quality of the asset that a seller holds is revealed and the market updates its belief about a seller`s type, which I refer to as reputation. Markets where sellers have a higher reputation have lower liquidity and higher prices. With reputational concerns, the downward liquidity distortions caused by adverse selection are exacerbated. Equilibrium selection is affected by the incentives sellers have to earn a higher reputation. Shocks to entry costs have larger effects when sellers can build a reputation through multiple matches with buyers. JEL classiffications: D82,G1.
Keywords: Adverse Selection, directed search, liquidity., reputation