Contagious Adverse Selection

29 Pages Posted: 22 Dec 2010

See all articles by Stephen Morris

Stephen Morris

MIT

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: November 30, 2010

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

Morris, Stephen Edward and Shin, Hyun Song, Contagious Adverse Selection (November 30, 2010). Economic Theory Center Working Paper No. 001-2010. Available at SSRN: https://ssrn.com/abstract=1729236 or http://dx.doi.org/10.2139/ssrn.1729236

Stephen Edward Morris (Contact Author)

MIT ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://economics.mit.edu/faculty/semorris

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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