A model of collateral, investment and adverse selection

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.Adverse Selection, Collateral, Investment, Lending Standards, Screening

Non-obviousness and Screening

The paper offers a novel justification for the non-obviousness patentability requirement. An innovation involves two stages: research results in a technology blueprint, which development transforms into a profitable activity. An innovator, who is either efficient or inefficient, must rely on outside finance for the development. Only patented technologies are developed. Strengthening the non-obviousness requirement alleviates adverse selection by discouraging inefficient innovators from doing research, but creates inefficiencies by excluding marginal innovations. We show that it is socially optimal to raise the non-obviousness requirement so as to exclude bad innovators; we also provide several robustness checks and discuss the policy implications

Adverse selection, credit and efficiency: The case of the missing market

We analyze a standard environment of adverse selection in credit markets. In our environment, entrepreneurs who are privately informed about the quality of their projects need to borrow from banks. Conventional wisdom says that, in this class of economies, the competitive equilibrium is typically inefficient. We show that this conventional wisdom rests on one implicit assumption: entrepreneurs can only borrow from banks. If an additional market is added to provide entrepreneurs with additional funds, efficiency can be attained in equilibrium. An important characteristic of this additional market is that it must be non-exclusive, in the sense that entrepreneurs must be able to simultaneously borrow from many different lenders operating in it. This makes it possible to attain efficiency by pooling all entrepreneurs in the new market while separating them in the market for bank loans.Adverse Selection, Credit Markets, Collateral, Screening

Adverse selection, credit and efficiency: The case of the missing market

We analyze a standard environment of adverse selection in credit markets. In our environment, entrepreneurs who are privately informed about the quality of their projects need to borrow in order to invest. Conventional wisdom says that, in this class of economies, the competitive equilibrium is typically inefficient. We show that this conventional wisdom rests on one implicit assumption: entrepreneurs can only access monitored lending. If a new set of markets is added to provide entrepreneurs with additional funds, efficiency can be attained in equilibrium. An important characteristic of these additional markets is that lending in them must be unmonitored, in the sense that it does not condition total borrowing or investment by entrepreneurs. This makes it possible to attain efficiency by pooling all entrepreneurs in the new markets while separating them in the markets for monitored loans.Adverse Selection, Credit Markets, Collateral, Monitored Lending, Screening

Genesis of market failure of adverse-selection-type in problem of effective capital allocation

The paper investigates the problem of possibility of investment allocation by economies according to adverse pattern, which can ultimately imply the rise of situation of market failure. We consider the transformation of “ideal” capital allocation into allocation of adverse-selection-type, which occurs as a result of migration of agents of different types. We conclude that the uncontrolled agents’ behavior, due to their bounded rationality, can lead to adverse selection state, when the less effective agents are investors in economies with most favorable investment climate, and vice versa

Genesis of market failure of adverse-selection-type in problem of effective capital allocation

The paper investigates the problem of possibility of investment allocation by economies according to adverse pattern, which can ultimately imply the rise of situation of market failure. We consider the transformation of “ideal” capital allocation into allocation of adverse-selection-type, which occurs as a result of migration of agents of different types. We conclude that the uncontrolled agents’ behavior, due to their bounded rationality, can lead to adverse selection state, when the less effective agents are investors in economies with most favorable investment climate, and vice versa

Wealth inequality, unequal opportunities and inefficient credit market

This paper investigates the impact of heterogeneous wealth on credit allocation from an egalitarian opportunity and an efficiency point of view. Under asymmetric information on both wealth and the responsibility variable there is no trade-off between equality and efficiency, actually wealth inequality delivers both inequality of opportunity and inefficiency. Due to decreasing absolute risk aversion, poor entrepreneurs, other things equal, realize better projects. This notwithstanding, due to the bidimensional hidden information, they may be rationed out or obtain a loan only at the cost of cross subsidizing bad projects realized by rich entrepreneurs. In the first case inefficiency arises in the form of insufficient investment, in the second in the form of inefficient projects being realized. An egalitarian redistribution of endowments may lead to perfect screening, no inefficiencies in the allocation of credit and equality of opportunity

Wealth Inequality and the Exploration of Novel Alternatives

I investigate whether wealth inequality hinders the discovery of novel alternatives in a competitive screening model. Agents can engage in experimentation, which may lead to the discovery of superior technologies, while wasting time with inferior ones. Talented agents are better at weeding out inferior actions, but talent is unobservable by lenders. When agents are poor, this causes an adverse selection problem and experimentation is also pursued by untalented agents. As economies become wealthier, this misallocation problem weakens. Higher inequality worsens the misallocation problem when the economy is rich, but can increase efficiency in poor economies

The factors inefficient allocation of investment between economies

The article deals with the problem of possibility of allocation of investment capital by economies. The situation, when the less effective investors find themselves in more favorable investment climate despite of rationality principle is considered, i.e. there is a situation adverse selection. The model describing investors’ behavior in the economy, characterized by an investment climate of some favorability, is developed. There was considered a behaviour of investors–maximizers and investors–satisficers. 2 cases are modeled: independence of the economic climate from the volume of available investments and limitedness of maximal volume of investments, and dependence of the economic climate from the volume of available investments and unlimitedness of maximal volume of investments. The profitableness of investments on the economic climate considered for exponential and logistic function. The analysis shows reasons for adverse selection have a fundamental behavioral basis. The given study allows concluding the investment market is not fully self-controlled and sometimes needs government intervention