Working Paper: CEPR ID: DP7737
Authors: Thomas Philippon; Vasiliki Skreta
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 Codes: D02; D62; D82; D86; E44; E58; G01; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government interventions (H53) | bank participation (G21) |
| bank participation (G21) | market interest rates (E43) |
| debt guarantees (H81) | bank participation (G21) |
| debt guarantees (H81) | market efficiency (G14) |
| equity injections (O16) | market efficiency (G14) |
| asset buybacks (G32) | market efficiency (G14) |