Equilibrium in financial markets with adverse selection

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Title: Equilibrium in financial markets with adverse selection
ISBN: 952-462-039-1
Author: Takalo, Tuomas ; Toivanen, Otto
Organization: Suomen Pankki
Series: Suomen Pankin keskustelualoitteita
ISSN: 0785-3572
Series year: 2003
Series number: 6/2003
Year of publication: 2003
Publication date: 4.3.2003
Published in: Published in Scandinavian Journal of Economics, Volume 114, Issue 2, June 2012: 601-628
DOI: 10.1111/j.1467-9442.2011.01685.x
Pages: 45 s.
Keywords: rahoitusmarkkinat; tehokkuus; osakkeet; mallit; adverse selection; osakerahoitus; velkarahoitus
JEL: D58; G14; G20; G28; G32
Abstract: We study a financial market adverse selection model where all agents are endowed with initial wealth and choose to invest as entrepreneurs or financiers, or not to invest.We show that often a lack of outside finance leads to the emergence of financial markets where availability of outside finance leads to autarky.We find that i) there exist Pareto-efficient and inefficient equilibria; ii) adverse selection has more severe consequences for poorer economies; iii) increasing initial wealth may cause a shift from Pareto-efficient to inefficient equilibrium; iv) increasing the proportion of agents with positive NPV projects causes a shift from inefficient to efficient equilibrium; v) equilibrium financial contracts are either equity-like or 'pure' debt contracts; vi) agents with negative (positive) NPV projects earn rents only in (non-)wealth-constrained economies; vii) agents earn rents only when employing pure debt contracts; and viii) removing storage technology destroys the only Pareto-efficient equilibrium in non-wealth-constrained economies.Our model enables analysis of various policies concerning financial stability, the need for sophisticated financial institutions, development aid, and the promotion of entrepreneurship. Key words: financial market efficiency, adverse selection, financial contracts, creation of firms. JEL classification numbers: D58, G14, G20, G28, G32
Rights: https://helda.helsinki.fi/bof/copyright

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