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Subsidizing price discovery

Listed author(s):
  • Braz Camargo
  • Kyungmin (Teddy) Kim
  • Benjamin Lester

When markets freeze, not only are gains from trade left unrealized, but the process of information production through prices, or price discovery, is disrupted as well. Though this latter effect has received much less attention than the former, it constitutes an important source of inefficiency during times of crisis. We provide a formal model of price discovery and use it to study a government program designed explicitly to restore the process of information production in frozen markets. This program, which provided buyers with partial insurance against acquiring low-quality assets, reveals a fundamental trade-off for policymakers: while some insurance encourages buyers to bid for assets when they otherwise would not, thus promoting price discovery, too much insurance erodes the informational content of these bids, which hurts price discovery.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-20.

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Date of creation: 2013
Handle: RePEc:fip:fedpwp:13-20
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  1. Dow, James & Gorton, Gary, 1997. " Stock Market Efficiency and Economic Efficiency: Is There a Connection?," Journal of Finance, American Finance Association, vol. 52(3), pages 1087-1129, July.
  2. Milgrom, Paul R, 1981. "Rational Expectations, Information Acquisition, and Competitive Bidding," Econometrica, Econometric Society, vol. 49(4), pages 921-943, June.
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  4. Emmanuel Farhi & Jean Tirole, 2012. "Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts," American Economic Review, American Economic Association, vol. 102(1), pages 60-93, February.
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  9. Laura L. Veldkamp, 2011. "Information Choice in Macroeconomics and Finance," Economics Books, Princeton University Press, edition 1, number 9621.
  10. Camargo, Braz & Lester, Benjamin, 2014. "Trading dynamics in decentralized markets with adverse selection," Journal of Economic Theory, Elsevier, vol. 153(C), pages 534-568.
  11. House, Christopher L. & Masatlioglu, Yusufcan, 2015. "Managing markets for toxic assets," Journal of Monetary Economics, Elsevier, vol. 70(C), pages 84-99.
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  13. V.V. Chari & Ali Shourideh & Ariel Zetlin-Jones, 2010. "Adverse Selection, Reputation and Sudden Collapses in Secondary Loan Markets," NBER Working Papers 16080, National Bureau of Economic Research, Inc.
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  15. Ilan Kremer, 2002. "Information Aggregation in Common Value Auctions," Econometrica, Econometric Society, vol. 70(4), pages 1675-1682, July.
  16. Robert Wilson, 1977. "A Bidding Model of Perfect Competition," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 511-518.
  17. Wolfgang Pesendorfer & Jeroen M. Swinkels, 1997. "The Loser's Curse and Information Aggregation in Common Value Auctions," Econometrica, Econometric Society, vol. 65(6), pages 1247-1282, November.
  18. Nicola Persico, 2000. "Information Acquisition in Auctions," Econometrica, Econometric Society, vol. 68(1), pages 135-148, January.
  19. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  20. Robert Shimer & Veronica Guerrieri, 2011. "Competitive Equilibrium in Asset Markets with Adverse Selection," 2011 Meeting Papers 565, Society for Economic Dynamics.
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