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Asymmetric information: the multiplier effect of financial instability

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  • Skardziukas, Domantas

Abstract

Financial markets and financial intermediation are essential to well-functioning economy. They perform the role of channeling funds to parties that have value creating investment opportunities. However, asymmetric information can seriously impair the process when parties to the financial contract are not fully aware of the risks involved and, as a result, can limit their exposure to financial agreements to prevent themselves from possible losses. Increasing asymmetric information as we explain in the article has a tendency to bring a ripple effect in the financial system. This negative money multiplier then sets the stage until it severely hampers money supply, productive investment opportunities and finally aggregate economic activity. The article introduces the reader with the framework of asymmetric information developed by several authors in the last few decades and builds on the recent financial developments that pose new challenges.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23013.

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Date of creation: 01 Mar 2010
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Handle: RePEc:pra:mprapa:23013

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Keywords: Asymmetric information; Financial instability; Credit spread; credit crunch; derivatives; downturn; recession; crisis forecast.;

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  1. Frederic S. Mishkin, 1991. "Asymmetric Information and Financial Crises: A Historical Perspective," NBER Chapters, in: Financial Markets and Financial Crises, pages 69-108 National Bureau of Economic Research, Inc.
  2. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
  3. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  4. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
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