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A model of collateral, investment and adverse selection

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Abstract

This paper characterizes the relationship between entrepreneurial wealth and aggregate investment under adverse selection. Its main finding is that such a relationship need not be monotonic. In particular, three results emerge from the analysis: (i) pooling equilibria, in which investment is independent of entrepreneurial wealth, are more likely to arise when entrepreneurial wealth is relatively low; (ii) separating equilibria, in which investment is increasing in entrepreneurial wealth, are most likely to arise when entrepreneurial wealth is relatively high and; (iii) for a given interest rate, an increase in entrepreneurial wealth may generate a discontinuous fall in investment.

Suggested Citation

  • Alberto Martin, 2009. "A model of collateral, investment and adverse selection," Economics Working Papers 1136, Department of Economics and Business, Universitat Pompeu Fabra.
    • Handle: RePEc:upf:upfgen:1136
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    1. Boyd, John H & Smith, Bruce D, 1993. "The Equilibrium Allocation of Investment Capital in the Presence of Adverse Selection and Costly State Verification," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 3(3), pages 427-451, July.
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    6. John G. Riley, 2001. "Silver Signals: Twenty-Five Years of Screening and Signaling," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 432-478, June.
    7. Alberto Martin, 2004. "Endogenous credit cycles," Economics Working Papers 916, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2008.
    8. Pradeep Dubey & John Geanakoplos, 2002. "Competitive Pooling: Rothschild-Stiglitz Reconsidered," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(4), pages 1529-1570.
    9. Giovanni Dell'Ariccia & Robert Marquez, 2006. "Lending Booms and Lending Standards," Journal of Finance, American Finance Association, vol. 61(5), pages 2511-2546, October.
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    11. Douglas Gale, 1992. "A Walrasian Theory of Markets with Adverse Selection," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(2), pages 229-255.
    12. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 629-649.
    13. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
    14. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
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    Cited by:

    1. Alberto Martin, 2008. "Adverse selection, credit and efficiency: The case of the missing market," Economics Working Papers 1085, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2009.
    2. Inci, Eren, 2013. "Occupational choice and the quality of entrepreneurs," Journal of Economic Behavior & Organization, Elsevier, vol. 92(C), pages 1-21.
    3. Alessandro Spiganti, 2022. "Wealth Inequality and the Exploration of Novel Alternatives," Working Papers 2022:02, Department of Economics, University of Venice "Ca' Foscari".
    4. Sokolovskyi, Dmytro, 2018. "The factors inefficient allocation of investment between economies," MPRA Paper 87032, University Library of Munich, Germany.
    5. Anastasios Dosis, 2016. "Investment, Adverse Selection and Optimal Redistributive Taxation," Working Papers hal-01285163, HAL.
    6. Niinimäki, Juha-Pekka, 2015. "The optimal allocation of alternative collateral assets between different loans," The North American Journal of Economics and Finance, Elsevier, vol. 34(C), pages 22-41.
    7. Shibata, Takashi & Nishihara, Michi, 2023. "Optimal financing and investment strategies under asymmetric information on liquidation value," Journal of Banking & Finance, Elsevier, vol. 146(C).
    8. Dosis, Anastasios, 2016. "Investment, Adverse Selection and Optimal Redistributive Taxation," ESSEC Working Papers WP1605, ESSEC Research Center, ESSEC Business School.
    9. Sokolovska, Olena & Sokolovskyi, Dmytro, 2012. "Genesis of market failure of adverse-selection-type in problem of effective capital allocation," MPRA Paper 41868, University Library of Munich, Germany.
    10. Jaimovich, Esteban, 2011. "Sectoral differentiation, allocation of talent, and financial development," Journal of Development Economics, Elsevier, vol. 96(1), pages 47-60, September.
    11. Kuncl, Martin, 2019. "Securitization under asymmetric information over the business cycle," European Economic Review, Elsevier, vol. 111(C), pages 237-256.
    12. Zonglai Kou & Patrick Rey & Tong Wang, 2013. "Non-Obviousness and Screening," Journal of Industrial Economics, Wiley Blackwell, vol. 61(3), pages 700-732, September.
    13. Ordoñez, Guillermo & Perez-Reyna, David & Yogo, Motohiro, 2019. "Leverage dynamics and credit quality," Journal of Economic Theory, Elsevier, vol. 183(C), pages 183-212.
    14. Hernández, Juan & Wills, Daniel, 2024. "Fighting for the Best, Losing with the Rest: The Perils of Competition in Entrepreneurial Finance," IDB Publications (Working Papers) 13362, Inter-American Development Bank.
    15. Coco, Giuseppe & Pignataro, Giuseppe, 2014. "The poor are twice cursed: Wealth inequality and inefficient credit market," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 149-159.
    16. Koji Asano, 2022. "Trust and Law in Credit Markets," Economica, London School of Economics and Political Science, vol. 89(354), pages 332-361, April.
    17. Praveen Kumar & Nisan Langberg, 2014. "Optimal Incentive Contracts and Information Cascades," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 3(1-2), pages 123-161.
    18. Kumar, Praveen & Langberg, Nisan, 2013. "Information manipulation and rational investment booms and busts," Journal of Monetary Economics, Elsevier, vol. 60(4), pages 408-425.
    19. Alin OPREANA & Simona VINEREAN, 2015. "Analysis of the Economic Research Context after the Outbreak of the Economic Crisis of 2007-2009," Expert Journal of Economics, Sprint Investify, vol. 3(1), pages 77-92.

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    More about this item

    Keywords

    Adverse Selection; Collateral; Investment; Lending Standards; Screening;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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