Optimal Interventions in Markets with Adverse Selection

TLDR

Participation in government programs carries stigma and depends on outside options. The study designs interventions to stabilize markets with adverse selection by analyzing information revealed through participation decisions. The authors analyze information revealed by participation decisions to inform intervention design. The study finds that intervention efficiency is measured by its effect on market interest rates, and that an outside market shapes optimal intervention types—such as debt guarantees—without affecting implementation costs. JEL codes: D82, D86, G01, G20, G31.

Abstract

We study the design of interventions to stabilize financial markets plagued by adverse selection. Our contribution is to analyze the information revealed by participation decisions. Taking part in a government program carries a stigma, and outside options are mechanism dependent. We show that the efficiency of an intervention can be assessed by its impact on the market interest rate. The presence of an outside market determines the nature of optimal interventions and the choice of financial instruments (debt guarantees in our model), but it does not affect implementation costs. (JEL D82, D86, G01, G20, G31)