IDEAS home Printed from https://ideas.repec.org/p/wbk/wbrwps/5183.html
   My bibliography  Save this paper

Dysfunctional finance : positive shocks and negative outcomes

Author

Listed:
  • Hoff, Karla

Abstract

This paper shows how badly a market economy may respond to a positive productivity shock in an environment with asymmetric information about project quality: some, all, or even more than all the benefits from the increase in productivity may be dissipated. In the model, based on Bernanke and Gertler (1990), entrepreneurs with a low default probability are charged the same interest rate as entrepreneurs with a high default probability. The implicit subsidy from good types to bad means that the marginal entrant will have a negative-value project. An example is presented in which, after a positive productivity shock, the presence of enough bad type's forces the interest rate so high that it drives all entrepreneurs out of the market. This happens in an industry in which there are good projects that are productive. The problem is that they are contaminated in the capital market by bad projects because of the banks inability to distinguish good projects from bad. One possible explanation for the lack of development in some countries is that screening institutions are sufficiently weak that impersonal financial markets cannot function. If industrialization entails learning spillovers concentrated within national boundaries, and if initially informational asymmetries are sufficiently great that the capital market does not emerge, then neither industrialization nor the learning that it would foster will occur.

Suggested Citation

  • Hoff, Karla, 2010. "Dysfunctional finance : positive shocks and negative outcomes," Policy Research Working Paper Series 5183, The World Bank.
  • Handle: RePEc:wbk:wbrwps:5183
    as

    Download full text from publisher

    File URL: http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2010/02/03/000333038_20100203233222/Rendered/PDF/WPS51830Replac10as0previous0record1.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Baskin, Jonathan Barron, 1988. "The Development of Corporate Financial Markets in Britain and the United States, 1600–1914: Overcoming Asymmetric Information," Business History Review, Cambridge University Press, vol. 62(02), pages 199-237, June.
    2. Gene M. Grossman & Henrik Horn, 1988. "Infant-Industry Protection Reconsidered: The Case of Informational Barriers to Entry," The Quarterly Journal of Economics, Oxford University Press, vol. 103(4), pages 767-787.
    3. Hausmann, Ricardo & Rodrik, Dani, 2003. "Economic development as self-discovery," Journal of Development Economics, Elsevier, vol. 72(2), pages 603-633, December.
    4. Black, Jane & de Meza, David, 1994. "The nature of credit-market failure," Economics Letters, Elsevier, vol. 46(3), pages 243-249, November.
    5. David de Meza & David C. Webb, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 281-292.
    6. Bruce C. Greenwald & Joseph E. Stiglitz, 1993. "Financial Market Imperfections and Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 108(1), pages 77-114.
    7. Stiglitz, Joseph E, 1975. "The Theory of "Screening," Education, and the Distribution of Income," American Economic Review, American Economic Association, vol. 65(3), pages 283-300, June.
    8. Davis,Lance E. & Cull,Robert J., 2002. "International Capital Markets and American Economic Growth, 1820–1914," Cambridge Books, Cambridge University Press, number 9780521526449.
    9. Acemoglu, Daron, 1998. "Credit Market Imperfections and the Separation of Ownership from Control," Journal of Economic Theory, Elsevier, vol. 78(2), pages 355-381, February.
    10. Bruce C. Greenwald & Joseph E. Stiglitz, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 229-264.
    11. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    12. H. Scott Gordon, 1954. "The Economic Theory of a Common-Property Resource: The Fishery," Journal of Political Economy, University of Chicago Press, vol. 62, pages 124-124.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Debt Markets; Access to Finance; Economic Theory&Research; Banks&Banking Reform; Markets and Market Access;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:5183. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi). General contact details of provider: http://edirc.repec.org/data/dvewbus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.