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Contagious Adverse Selection

Author

Listed:
  • Stephen Morris

    (Princeton University)

  • Hyun Song Shin

    (Princeton University)

Abstract

We illustrate the corrosive effect of even small amounts of adverse selection in an asset market and how it can lead to the total breakdown of trade. The problem is the failure of "market confidence", defined as approximate common knowledge of an upper bound on expected losses. Small probability events can unravel market confidence. We discuss the role of contagious adverse selection and the problem of "toxic assets" in the recent financial crisis.

Suggested Citation

  • Stephen Morris & Hyun Song Shin, 2010. "Contagious Adverse Selection," Working Papers 1251, Princeton University, Department of Economics, Econometric Research Program..
  • Handle: RePEc:pri:metric:fi001.pdf
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    References listed on IDEAS

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    Cited by:

    1. Sylvain Benoit & Jean-Edouard Colliard & Christophe Hurlin & Christophe Pérignon, 2017. "Where the Risks Lie: A Survey on Systemic Risk," Review of Finance, European Finance Association, vol. 21(1), pages 109-152.
    2. Goldstein, Itay & Razin, Assaf, 2015. "Three Branches of Theories of Financial Crises," Foundations and Trends(R) in Finance, now publishers, vol. 10(2), pages 113-180, 30.
    3. Foley-Fisher, Nathan & Ramcharan, Rodney & Yu, Edison, 2016. "The impact of unconventional monetary policy on firm financing constraints: Evidence from the maturity extension program," Journal of Financial Economics, Elsevier, vol. 122(2), pages 409-429.
    4. Morris, Stephen & Shin, Hyun Song & Yildiz, Muhamet, 2016. "Common belief foundations of global games," Journal of Economic Theory, Elsevier, vol. 163(C), pages 826-848.
    5. Moreno, Diego & Wooders, John, 2016. "Dynamic markets for lemons: performance, liquidity, and policy intervention," Theoretical Economics, Econometric Society, vol. 11(2), May.
    6. Welburn, Jonathan William & Hausken, Kjell, 2015. "A Game-Theoretic Model with Empirics of Economic Crises," UiS Working Papers in Economics and Finance 2015/7, University of Stavanger.
    7. repec:eee:jetheo:v:176:y:2018:i:c:p:761-802 is not listed on IDEAS
    8. Marco di Maggio & Marco Pagano, 2012. "Financial Disclosure and Market Transparency with Costly Information Processing," CSEF Working Papers 323, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 23 Jul 2016.
    9. Welburn, Jonathan & Hausken, Kjell, 2014. "Game-Theoretic Perspectives on Financial Crises," UiS Working Papers in Economics and Finance 2014/22, University of Stavanger.
    10. Carroll, Gabriel, 2016. "Informationally robust trade and limits to contagion," Journal of Economic Theory, Elsevier, vol. 166(C), pages 334-361.
    11. Anne-Marie Rieu-Foucault, 2017. "Point sur la fourniture de liquidié publique," EconomiX Working Papers 2017-27, University of Paris Nanterre, EconomiX.
    12. Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Research Discussion Papers 4/2017, Bank of Finland.
    13. Grzegorz Hałaj & Christoffer Kok, 2013. "Assessing interbank contagion using simulated networks," Computational Management Science, Springer, vol. 10(2), pages 157-186, June.
    14. Chernenko, Sergey & Hanson, Samuel Gregory & Sunderam, Adi, 2014. "The Rise and Fall of Demand for Securitizations," Working Paper Series 2014-16, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    15. Jonathan William Welburn & Kjell Hausken, 2017. "Game Theoretic Modeling of Economic Systems and the European Debt Crisis," Computational Economics, Springer;Society for Computational Economics, vol. 49(2), pages 177-226, February.
    16. Anne-Marie Rieu-Foucault, 2018. "Les interventions de crise de la FED et de la BCE diffèrent-elles ?," EconomiX Working Papers 2018-31, University of Paris Nanterre, EconomiX.
    17. repec:the:publsh:2543 is not listed on IDEAS
    18. repec:eee:jetheo:v:176:y:2018:i:c:p:255-292 is not listed on IDEAS
    19. Agur, Itai, 2013. "Multiple bank regulators and risk taking," Journal of Financial Stability, Elsevier, vol. 9(3), pages 259-268.
    20. Welburn, Jonathan W. & Hausken, Kjell, 2015. "A game theoretic model of economic crises," Applied Mathematics and Computation, Elsevier, vol. 266(C), pages 738-762.
    21. Timothy Shields & Baohua Xin, 2012. "Higher-order Beliefs in Simple Trading Models," Working Papers 12-18, Chapman University, Economic Science Institute.
    22. Prokopczuk, Marcel & Siewert, Jan B. & Vonhoff, Volker, 2013. "Credit risk in covered bonds," Journal of Empirical Finance, Elsevier, vol. 21(C), pages 102-120.
    23. repec:eee:moneco:v:100:y:2018:i:c:p:101-113 is not listed on IDEAS
    24. Bental, Benjamin & Demougin, Dominique, 2016. "Privatizing profits and socializing losses with smoothly operating capital markets," European Journal of Political Economy, Elsevier, vol. 44(C), pages 179-194.

    More about this item

    Keywords

    market confidence; adverse selection; trade; market condence; financial crisis;

    JEL classification:

    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts
    • C40 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - General

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