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Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning

  • Jean Tirole

The paper provides a first analysis of market jump starting and its two-way interaction between mechanism design and participation constraints. The government optimally overpays for the legacy assets and cleans up the market of its weakest assets, through a mixture of buybacks and equity injections, and leaves the firms with the strongest legacy assets to the market. The government reduces adverse selection enough to let the market rebound, but not too much, so as to limit the cost of intervention. The existence of a market imposes no welfare cost. (JEL D82, D83, G01, G31, H81)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.1.29
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 102 (2012)
Issue (Month): 1 (February)
Pages: 29-59

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Handle: RePEc:aea:aecrev:v:102:y:2012:i:1:p:29-59
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  1. Zhiguo He & In Gu Khang & Arvind Krishnamurthy, 2010. "Balance Sheet Adjustments during the 2008 Crisis," IMF Economic Review, Palgrave Macmillan, vol. 58(1), pages 118-156, August.
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