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Asset Quality Cycles

Masao Fukui

Journal of Monetary Economics, 2018, vol. 95, issue C, 97-108

Abstract: Systemic risk builds up during booms in an economy featuring asymmetric information in asset markets, where investors’ hidden effort choices endogenously determine asset quality distribution. Higher asset prices during booms induce more investors to sell their assets, which lowers their incentive to improve quality. This quality deterioration in turn makes the economy vulnerable to future exogenous shocks because market breakdowns become more likely. Private agents do not internalize that their effort choices worsen future adverse selection problems, and thus the planner may improve welfare by taxing trade and thereby lowering asset prices.

Keywords: Adverse selection; Endogenous quality; Moral hazard; Business cycle (search for similar items in EconPapers)
JEL-codes: D82 E32 E44 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:moneco:v:95:y:2018:i:c:p:97-108