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Contagious Adverse Selection

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  • 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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    More about this item

    Keywords

    market confidence; adverse selection; trade; market condence; financial crisis;
    All these keywords.

    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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