NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Feng Dong

Shanghai Jiao Tong University
Fahuazhen Rd 535
Changning District, Shanghai, China
Tel: (+86) 21-52301590

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NBER Working Papers and Publications

October 2014Adverse Selection and Self-fulfilling Business Cycles
with Jess Benhabib, Pengfei Wang: w20642
We introduce a simple adverse selection problem arising in credit markets into a standard textbook real business cycle model. There is a continuum of households and a continuum of anonymous producers who produce the final goods from intermediate goods. These producers do not have the resources to make up-front payments to purchase inputs and must do so by borrowing from competitive financial intermediates. However, lending to these producers is risky: honest borrowers will always pay off their debt, but dishonest borrowers will always default. This gives rise to an adverse selection problem for financial intermediaries. In a continuous-time real business cycle setting we show that such adverse selection generates multiple steady states and both local and global indeterminacy, and can give ...
 
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