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Adverse Selection, Lemons Shocks and Business Cycles

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  • Daisuke Ikeda

Abstract

Asymmetric information is crucial for understanding the disruption of the supply of credit. This paper studies a dynamic economy featuring asymmetric information and resulting adverse selection in credit markets. Entrepreneurs seek loans from banks for projects, but asymmetric information about entrepreneurs' riskiness causes a lemons problem: relatively safe entrepreneurs do not get funded. An increase in the riskiness of some entrepreneurs raises interest rate spreads, aggravates adverse selection, and shrinks the supply of bank credit. The model calibrated to the U.S. economy generates significant business fluctuations including severe recessions comparable to the Great Recession of 2007-09.

Suggested Citation

  • Daisuke Ikeda, 2019. "Adverse Selection, Lemons Shocks and Business Cycles," Globalization Institute Working Papers 361, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddgw:361
    DOI: 10.24149/gwp361
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    Cited by:

    1. Lawrence Christiano & Daisuke Ikeda, 2011. "Government Policy, Credit Markets and Economic Activity," NBER Working Papers 17142, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    Adverse selection; Mechanism design approach; separating contract;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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