Dysfunctional Finance: Positive Shocks and Negative Outcomes

Karla Hoff

Journal of Globalization and Development, 2010, vol. 1, issue 1, 24

Abstract: In financial markets with asymmetric information about mean returns, borrowers with different default risks may pay the same rate of interest. If they do, the marginal borrower will have a high-risk, negative-value project. Under some conditions, technological change that increases each entrepreneur's output will attract a new set of negative-value projects. This adverse selection process will erode the ability rents of the inframarginal borrowers. I present an example in which it destroys the market. The results imply that a boom in a sector can lead to a crisis if institutional change to solve the screening problem does not occur.

Keywords: adverse selection; financial fragility; informational externality; tragedy of the commons (search for similar items in EconPapers)
Date: 2010
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DOI: 10.2202/1948-1837.1017

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