Optimal Interventions in Markets with Adverse Selection

43 Pages Posted: 17 Mar 2010

See all articles by Thomas Philippon

Thomas Philippon

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Vasiliki Skreta

University of Texas at Austin - Department of Economics; University College London

Multiple version iconThere are 3 versions of this paper

Date Written: March 2010

Abstract

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.

Keywords: adverse selection, bailout, financial crisis, information, mechanism design

JEL Classification: D02, D62, D82, D86, E44, E58, G01, G2

Suggested Citation

Philippon, Thomas and Skreta, Vasiliki, Optimal Interventions in Markets with Adverse Selection (March 2010). CEPR Discussion Paper No. DP7737, Available at SSRN: https://ssrn.com/abstract=1573441

Thomas Philippon (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Vasiliki Skreta

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

HOME PAGE: http://vskreta.wixsite.com/vskreta

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

HOME PAGE: http://vskreta.wixsite.com/vskreta

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