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Optimal Interventions in Markets with Adverse Selection

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  • Philippon, Thomas
  • Skreta, Vasiliki

Abstract

We study interventions to restore efficient lending and investment when financial markets fail because of adverse selection. We solve a design problem where the decision to participate in a program offered by the government can be a signal for private information. We charac terize optimal mechanisms and analyze specific programs often used during banking crises. We show that programs attracting all banks dominate those attracting only troubled banks, and that simple guarantees for new debt issuances implement the optimal mechanism, while equity injections and asset buyback do not. We also discuss the consequences of moral hazard.

Suggested Citation

  • Philippon, Thomas & Skreta, Vasiliki, 2010. "Optimal Interventions in Markets with Adverse Selection," CEPR Discussion Papers 7737, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:7737
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    adverse selection; bailout; financial crisis; information; mechanism design;

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G2 - Financial Economics - - Financial Institutions and Services

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