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Optimal Interventions in Markets with Adverse Selection

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  • Thomas Philippon
  • Vasiliki Skreta

Abstract

We characterize cost-minimizing interventions to restore lending and investment when markets fail due to adverse selection. We solve a mechanism design problem where the strategic decision to participate in a government's program signals information that affects the financing terms of non-participating borrowers. In this environment, we find that the government cannot selectively attract good borrowers, that the efficiency of an intervention is fully determined by the market rate for non-participating borrowers, and that simple programs of debt guarantee are optimal, while equity injections or asset purchases are not. Finally, the government does not benefit from shutting down private markets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15785.

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Date of creation: Feb 2010
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Publication status: published as Thomas Philippon & Vasiliki Skreta, 2012. "Optimal Interventions in Markets with Adverse Selection," American Economic Review, American Economic Association, vol. 102(1), pages 1-28, February.
Handle: RePEc:nbr:nberwo:15785

Note: CF EFG ME PE
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Cited by:
  1. Kyungmin Kim & Benjamin Lester & Braz Camargo, 2012. "Subsidizing Price Discovery," 2012 Meeting Papers, Society for Economic Dynamics 338, Society for Economic Dynamics.
  2. Braz Camargo & Benjamin Lester, 2011. "Trading dynamics in decentralized markets with adverse selection," Working Papers 11-36, Federal Reserve Bank of Philadelphia.
  3. Mariotti, Thomas & Salanié, François & Attar, Andrea, 2014. "Nonexclusive competition under adverse selection," Theoretical Economics, Econometric Society, Econometric Society, vol. 9(1), January.
  4. Bernardo, Antonio & Talley, Eric & Welch, Ivo, 2011. "A Model of Optimal Government Bailouts," Berkeley Olin Program in Law & Economics, Working Paper Series, Berkeley Olin Program in Law & Economics qt8wv4p90c, Berkeley Olin Program in Law & Economics.
  5. Saki Bigio, 2012. "Financial Risk Capacity," 2012 Meeting Papers, Society for Economic Dynamics 97, Society for Economic Dynamics.
  6. Koufopoulos, Kostos & Kozhan, Roman & Trigilia, Giulio, 2014. "Optimal Security Design under Asymmetric Information and Profit Manipulation," The Warwick Economics Research Paper Series (TWERPS) 1050, University of Warwick, Department of Economics.
  7. Huberto M. Ennis & John A. Weinberg, 2010. "Over-the-counter loans, adverse selection, and stigma in the interbank market," Working Paper, Federal Reserve Bank of Richmond 10-07, Federal Reserve Bank of Richmond.
  8. Celik, Gorkem & Peters, Michael, 2011. "Reciprocal Relationships and Mechanism Design," Microeconomics.ca working papers, Vancouver School of Economics gorkem_celik-2011-19, Vancouver School of Economics, revised 01 Aug 2011.
  9. Celik, Gorkem & Peters, Michael, 2011. "Equilibrium rejection of a mechanism," Games and Economic Behavior, Elsevier, Elsevier, vol. 73(2), pages 375-387.
  10. Jean Tirole, 2012. "Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning," American Economic Review, American Economic Association, American Economic Association, vol. 102(1), pages 29-59, February.
  11. Jimmy Melo, 2014. "Expectativas cambiarias, selección adversa y liquidez," Ensayos Revista de Economia, Universidad Autonoma de Nuevo Leon, Facultad de Economia, vol. 0(1), pages 27-62, May.
  12. House, Christopher & Masatlioglu, Yusufcan, 2010. "Managing Markets for Toxic Assets," MPRA Paper 24590, University Library of Munich, Germany.
  13. Sokolovska, Olena & Sokolovskyi, Dmytro, 2012. "Genesis of market failure of adverse-selection-type in problem of effective capital allocation," MPRA Paper 41868, University Library of Munich, Germany.
  14. Sweder van Wijnbergen & Timotej Homar, 2013. "Recessions after Systemic Banking Crises: Does it matter how Governments intervene?," Tinbergen Institute Discussion Papers 13-039/VI/DSF54, Tinbergen Institute, revised 21 Nov 2013.
  15. Fuchs, William & Skrzypacz, Andrzej, 2013. "Costs and Benefits of Dynamic Trading in a Lemons Market," Research Papers, Stanford University, Graduate School of Business 2133, Stanford University, Graduate School of Business.
  16. Itay Goldstein & Assaf Razin, 2013. "Three Branches of Theories of Financial Crises," NBER Working Papers 18670, National Bureau of Economic Research, Inc.
  17. Koralai Kirabaeva, 2010. "Adverse Selection, Liquidity, and Market Breakdown," Working Papers, Bank of Canada 10-32, Bank of Canada.
  18. Hajime Tomura, 2012. "Asset Illiquidity and Market Shutdowns in Competitive Equilibrium," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 283-294, July.

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