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Optimal Interventions in Markets with Adverse Selection

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  • Thomas Philippon
  • Vasiliki Skreta

Abstract

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.

Suggested Citation

  • Thomas Philippon & Vasiliki Skreta, 2010. "Optimal Interventions in Markets with Adverse Selection," NBER Working Papers 15785, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:15785
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    More about this item

    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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