Optimal Interventions in Markets with Adverse Selection
34 Pages Posted: 6 Dec 2010
Date Written: September 2011
We study the design of interventions to stabilize financial markets plagued by adverse selection. Our contribution is to analyze the information revealed by participation decisions. Taking part in a government program carries a stigma, and outside options are mechanism-dependent. We show that the effciency of an intervention can be assessed by its impact on the market interest rate. The presence of an outside market determines the nature of optimal interventions and the choice of financial instruments (debt guarantees in our model), but it does not affect implementation costs.
Keywords: adverse selection, market collapse, mechanism design, mechanism-dependent participation
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