Equilibrium in financial markets with adverse selection

Arbeitspapier

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.

Object Details

• ISBN: 952-462-039-1
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bank of Finland Discussion Papers ; No. 6/2003

Classification and Topics

• Classification: Wirtschaft ; Computable and Other Applied General Equilibrium Models ; Information and Market Efficiency; Event Studies; Insider Trading ; Financial Institutions and Services: General ; Financial Institutions and Services: Government Policy and Regulation ; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
• Subject: financial market efficiency ; adverse selection ; financial contracts ; creation of firms

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Takalo, Tuomas ; Toivanen, Otto
• Event: Veröffentlichung
• (who): Bank of Finland
• (where): Helsinki
• (when): 2003

Further information

• Handle: http://hdl.handle.net/10419/211939
• Last update: 10.03.2025, 11:44 AM CET