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American Economic Review: Vol. 102 No. 1 (February 2012)

AER Volume. 102, Issue 1 | Previous ArticleNext Article

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Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning

Article Citation

Tirole, Jean. 2012. "Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning." American Economic Review, 102(1): 29-59.

DOI: 10.1257/aer.102.1.29

Abstract

The paper provides a first analysis of market jump starting and its two-way interaction between mechanism design and participation constraints. The government optimally overpays for the legacy assets and cleans up the market of its weakest assets, through a mixture of buybacks and equity injections, and leaves the firms with the strongest legacy assets to the market. The government reduces adverse selection enough to let the market rebound, but not too much, so as to limit the cost of intervention. The existence of a market imposes no welfare cost. (JEL D82, D83, G01, G31, H81)

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Additional Materials

Online Appendix (57.06 KB)

Authors

Tirole, Jean (Toulouse School of Economics and U Toulouse)

JEL Classifications

D82: Asymmetric and Private Information
D83: Search; Learning; Information and Knowledge; Communication; Belief
G01: Financial Crises
G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
H81: Governmental Loans, Loan Guarantees, Credits, and Grants