Adverse Selection, Lemons Shocks and Business Cycles

Daisuke Ikeda

No 361, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: Asymmetric information is crucial for understanding the disruption of 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)
Pages: 38 pages
Date: 2019-04-01
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-mac
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https://www.dallasfed.org/~/media/documents/institute/wpapers/2019/0361.pdf Paper (application/pdf)
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Related works:
Journal Article: Adverse selection, lemons shocks and business cycles (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:361

DOI: 10.24149/gwp361

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