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Optimal Interventions in Markets with Adverse Selection

  • Thomas Philippon
  • Vasiliki Skreta

We study interventions to restore efficient lending and investment when financial markets fail because of adverse selection. We solve a design problem where the decision to participate in a program offered by the government can be a signal for private information. We charac terize optimal mechanisms and analyze specific programs often used during banking crises. We show that programs attracting all banks dominate those attracting only troubled banks, and that simple guarantees for new debt issuances implement the optimal mechanism, while equity injections and asset buyback do not. We also discuss the consequences of moral hazard.

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File URL: http://web-docs.stern.nyu.edu/old_web/economics/docs/workingpapers/2011/Skreta-OptimalInterventions,%20Apr2011.pdf
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Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 11-11.

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Date of creation: 2011
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Handle: RePEc:ste:nystbu:11-11
Contact details of provider: Postal: New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126
Phone: (212) 998-0860
Fax: (212) 995-4218
Web page: http://w4.stern.nyu.edu/economics/

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