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Dysfunctional Finance: Positive Shocks and Negative Outcomes

Listed author(s):
  • Hoff Karla

    (World Bank)

In financial markets with asymmetric information about mean returns, borrowers with different default risks may pay the same rate of interest. If they do, the marginal borrower will have a high-risk, negative-value project. Under some conditions, technological change that increases each entrepreneurs output will attract a new set of negative-value projects. This adverse selection process will erode the ability rents of the inframarginal borrowers. I present an example in which it destroys the market. The results imply that a boom in a sector can lead to a crisis if institutional change to solve the screening problem does not occur.

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Article provided by De Gruyter in its journal Journal of Globalization and Development.

Volume (Year): 1 (2010)
Issue (Month): 1 (January)
Pages: 1-24

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Handle: RePEc:bpj:globdv:v:1:y:2010:i:1:n:4
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  1. David de Meza & David C. Webb, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 281-292.
  2. Davis,Lance E. & Cull,Robert J., 1994. "International Capital Markets and American Economic Growth, 1820–1914," Cambridge Books, Cambridge University Press, number 9780521460545, December.
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  4. Joseph E. Stiglitz, 1973. "The Theory of 'Screening', Education, and the Distribution of Income," Cowles Foundation Discussion Papers 354, Cowles Foundation for Research in Economics, Yale University.
  5. Baskin, Jonathan Barron, 1988. "The Development of Corporate Financial Markets in Britain and the United States, 1600–1914: Overcoming Asymmetric Information," Business History Review, Cambridge University Press, vol. 62(02), pages 199-237, June.
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  7. Hausmann, Ricardo & Rodrik, Dani, 2002. "Economic Development as Self Discovery," CEPR Discussion Papers 3356, C.E.P.R. Discussion Papers.
  8. Bruce C. Greenwald & Joseph E. Stiglitz, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 229-264.
  9. Acemoglu, Daron, 1998. "Credit Market Imperfections and the Separation of Ownership from Control," Journal of Economic Theory, Elsevier, vol. 78(2), pages 355-381, February.
  10. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
  11. Black, Jane & de Meza, David, 1994. "The nature of credit-market failure," Economics Letters, Elsevier, vol. 46(3), pages 243-249, November.
  12. H. Scott Gordon, 1954. "The Economic Theory of a Common-Property Resource: The Fishery," Journal of Political Economy, University of Chicago Press, vol. 62, pages 124-124.
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