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American Economic Journal: Macroeconomics: Vol. 4 No. 1 (January 2012)

AEJ: Macro Volume. 4, Issue 1 | Previous ArticleNext Article

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Contagious Adverse Selection

Article Citation

Morris, Stephen, and Hyun Song Shin. 2012. "Contagious Adverse Selection." American Economic Journal: Macroeconomics, 4(1): 1-21.

DOI: 10.1257/mac.4.1.1

Abstract

We illustrate the corrosive effect of even small amounts of adverse selection in an asset market and show how it can lead to the total breakdown of trade. The problem is the failure of "market confidence," defined as approximate common knowledge of an upper bound on expected losses. Small probability events can unravel market confidence. We discuss the role of contagious adverse selection and the problem of "toxic assets" in the recent financial crisis. (JEL D82, G01, G12, G14)

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Authors

Morris, Stephen (Princeton U)
Shin, Hyun Song (Princeton U)

JEL Classifications

D82: Asymmetric and Private Information
G01: Financial Crises
G12: Asset Pricing; Trading volume; Bond Interest Rates
G14: Information and Market Efficiency; Event Studies

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