Adverse selection, lemons shocks and business cycles

Daisuke Ikeda

Journal of Monetary Economics, 2020, vol. 115, issue C, 94-112

Abstract: Asymmetric information is crucial for understanding disruptions in the supply of credit. This paper studies a dynamic economy featuring asymmetric information and resulting adverse selection in credit markets. Entrepreneurs seek loans from banks for projects, but asymmetric information about entrepreneurs’ riskiness causes a lemons problem: relatively safe entrepreneurs do not get funded. An increase in the riskiness of some entrepreneurs raises interest rate spreads, aggravates adverse selection, and shrinks the supply of bank credit. The model calibrated to the U.S. economy generates significant business fluctuations including severe recessions comparable to the Great Recession of 2007-09.

Keywords: Adverse selection; Mechanism design approach; Separating contract (search for similar items in EconPapers)
JEL-codes: D82 E32 E44 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: Adverse Selection, Lemons Shocks and Business Cycles (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:115:y:2020:i:c:p:94-112

DOI: 10.1016/j.jmoneco.2019.05.005

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