Adverse Selection and Risk Aversion in Capital Markets

Luis Braido (), Carlos Eugênio da Costa () and Bev Dahlby ()

No 2009-15, Working Papers from University of Alberta, Department of Economics

Abstract: We generalize the Boadway and Keen (2006) model of adverse selection in a capital market to allow for risk aversion on the part of entrepreneurs. We show that the Boadway and Keen conclusion-that adverse selection leads to excessive investment-does not necessarily hold when entrepreneurs are risk averse. We use their framework, with the additional assumption of risk aversion, to analyze the effect of policies that would reduce entrepreneurs' reliance on debt or equity financing by outside investors. We show that such policies, by exposing entrepreneurs to more down-side risk, may reduce the level of investment in risky projects, increase inequality and potentially reduce social welfare.

Keywords: adverse selection; capital markets; inefficiency; risk and entrepreneurship (search for similar items in EconPapers)
JEL-codes: D82 G14 O16 O17 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2009-03-16, Revised 2010-07-07
New Economics Papers: this item is included in nep-cta, nep-ent and nep-upt
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Related works:
Journal Article: Adverse Selection and Risk Aversion in Capital Markets (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:ris:albaec:2009_015

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