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Optimal Interventions in Markets with Adverse Selection

  • Thomas Philippon
  • Vasiliki Skreta

We characterize cost-minimizing interventions to restore lending and investment when markets fail due to adverse selection. We solve a mechanism design problem where the strategic decision to participate in a government's program signals information that affects the financing terms of non-participating borrowers. In this environment, we find that the government cannot selectively attract good borrowers, that the efficiency of an intervention is fully determined by the market rate for non-participating borrowers, and that simple programs of debt guarantee are optimal, while equity injections or asset purchases are not. Finally, the government does not benefit from shutting down private markets.

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File URL: http://www.nber.org/papers/w15785.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15785.

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Date of creation: Feb 2010
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Publication status: published as Thomas Philippon & Vasiliki Skreta, 2012. "Optimal Interventions in Markets with Adverse Selection," American Economic Review, American Economic Association, vol. 102(1), pages 1-28, February.
Handle: RePEc:nbr:nberwo:15785
Note: CF EFG ME PE
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