Working Paper: NBER ID: w15785
Authors: Thomas Philippon; Vasiliki Skreta
Abstract: We characterize cost-minimizing interventions to restore lending and investment when markets fail due to adverse selection. We solve a mechanism design problem where the strategic decision to participate in a government's program signals information that affects the financing terms of non-participating borrowers. In this environment, we find that the government cannot selectively attract good borrowers, that the efficiency of an intervention is fully determined by the market rate for non-participating borrowers, and that simple programs of debt guarantee are optimal, while equity injections or asset purchases are not. Finally, the government does not benefit from shutting down private markets.
Keywords: adverse selection; government intervention; mechanism design; financial markets
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 Intervention (L59) | Borrowing Rate of Nonparticipating Banks (G21) |
| Borrowing Rate of Nonparticipating Banks (G21) | Investment Levels of Participating Banks (G21) |
| Market Rate for Nonparticipating Borrowers (E43) | Investment Levels of Participating Banks (G21) |
| Size of Program (C88) | Government Intervention Costs (D61) |
| Government Intervention Using Debt Contracts (H63) | Optimal Intervention (C61) |