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The role of comparing in financial markets with hidden information

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  • Niinimäki, Juha-Pekka
  • Takalo, Tuomas
  • Kultti, Klaus

Abstract

This paper studies how comparing can be used to provide information in financial markets in the presence of a hidden characteristics problem.Although an investor cannot precisely estimate the future returns of an entrepreneur's projects, the investor can mitigate the asymmetric information problem by ranking different entrepreneurs and financing only the very best ones.Information asymmetry can be eliminated with certainty if the number of compared projects is sufficiently large.Because comparing favours centralised information gathering, it creates a novel rationale for the establishment of a financial intermediary.Key words: asymmetric information, banking, corporate finance, financial intermediation, ranking, venture capital JEL classification numbers: G21, G24

Suggested Citation

  • Niinimäki, Juha-Pekka & Takalo, Tuomas & Kultti, Klaus, 2006. "The role of comparing in financial markets with hidden information," Research Discussion Papers 1/2006, Bank of Finland.
  • Handle: RePEc:bof:bofrdp:2006_001
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    References listed on IDEAS

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    1. Pagano, Marco & Jappelli, Tullio, 1993. " Information Sharing in Credit Markets," Journal of Finance, American Finance Association, vol. 48(5), pages 1693-1718, December.
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    3. Bergemann, Dirk & Hege, Ulrich, 1998. "Venture capital financing, moral hazard, and learning," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 703-735, August.
    4. Martin F. Hellwig, 2000. "Financial Intermediation with Risk Aversion," Review of Economic Studies, Oxford University Press, vol. 67(4), pages 719-742.
    5. Dirk Bergemann & Ulrich Hege, 2002. "The Value of Benchmarking," Cowles Foundation Discussion Papers 1379, Cowles Foundation for Research in Economics, Yale University, revised Oct 2002.
    6. Bengt Holmstrom & Jean Tirole, 1997. "Financial Intermediation, Loanable Funds, and The Real Sector," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 663-691.
    7. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    8. Gorton, Gary & Winton, Andrew, 2003. "Financial intermediation," Handbook of the Economics of Finance,in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 8, pages 431-552 Elsevier.
    9. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
    10. Cerasi, Vittoria & Daltung, Sonja, 2000. "The optimal size of a bank: Costs and benefits of diversification," European Economic Review, Elsevier, vol. 44(9), pages 1701-1726, October.
    11. Ram T. S. Ramakrishnan & Anjan V. Thakor, 1984. "Information Reliability and a Theory of Financial Intermediation," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 415-432.
    12. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    13. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, vol. 58(2), pages 429-452, March.
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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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