Entrepreneurship and Financial Markets with Adverse Selection

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Title: Entrepreneurship and Financial Markets with Adverse Selection
Author: Takalo, Tuomas; Toivanen, Otto
Belongs to series: 7
ISBN: 951-555-803-4
Abstract: We study an adverse selection model where all agents are endowed with initial wealth, are nonetheless capital constrained, and choose to invest as entrepreneurs or financiers, or not to invest. We show that entrepreneurship and financial markets can arise in many cases where opening the markets to outside investors (i.e., financial market liberalization) would lead to them being eliminated. We find that without outside investors i) there exist Pareto-efficient and inefficient equilibria; ii) adverse selection has severer consequences in poorer economies; iii) increasing initial wealth may lead from a Paretoefficient to an inefficient equilibrium; iv) increasing the proportion of agents with positive NPV projects leads from an inefficient to an efficient equilibrium; v) agents with negative (positive) NPV projects only earn rents in (non)-wealth constrained economies; and vi) removing the storage technology destroys the only Pareto-efficient equilibrium in non-wealth constrained economies. Our model allows us to analyze various policies concerning financial market integration and liberalization, financial stability, the need for sophisticated financial institutions, development aid, and the promotion of entrepreneurship.
URI: http://hdl.handle.net/10138/135780
Date: 2004-01-08

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