Presentation_2-3_marked - Roles of financial institutions...

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Roles of financial institutions Econ 312 Prof. M. Cahill Fall 2009
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Asymmetric information Example 1: Loan IOUs promise to pay $1,000 in one year 50% of loans will make payment 50% will default on half payment Actually pay $500 Borrowers know if will default Lenders cannot tell which will default Assuming 0% interest, what is equilibrium loan price? .
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Asymmetric information Adverse selection Those most likely to seek loans are likely to be the most risky From insurance: those who seek insurance are most likely to need it Problem may get worse at higher interest rates Risky lenders expect to default on some interest, so don’t care as much
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Asymmetric information Adverse selection Market solution Only best-known firms can sell on markets Less-well-known borrow from “intermediaries” Acquire assets, sell own liabilities Screen applicants, identify lowest risk However, impact of adverse selection is fewer projects are funded Unfunded projects may have been the most productive
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This note was uploaded on 02/19/2010 for the course ECON 1313212 taught by Professor John during the Spring '09 term at The School of the Art Institute of Chicago.

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Presentation_2-3_marked - Roles of financial institutions...

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