Valuation, Adverse Selection, and Market Collapses
We study a market for funding real investment in which valuation creates information on which adverse selection can occur. Unlike in previous models, higher amounts of valuation are associated with lower market prices and so greater returns to valuation, and this strategic complementarity in the capacity to do valuation generates multiple equilibria. In this region, the equilibrium without valuation is always more efficient despite funding projects that valuation would reveal as unprofitable. Valuation equilibria look like credit crunches. A large investor can ensure the efficient equilibrium only if it can precommit to a price and, for some parameters, only if subsidized.
A draft of this paper was presented in 2009 and the first half of 2010 under the name "Valuation and the Volatility of Investment." For helpful comments, we thank Andrea Eisfeldt, V.V. Chari, Gary Gorton, Igal Hendel, Alessandro Lizzeri, Andrew Nowobilski, Alessandro Pavan, George Pennacchi, Andrew Winton, Haoxiang Zhu, two anonymous referees, and seminar participants at Brown, Chicago, Columbia, Northwestern, Stanford, Texas, Yale, the 2010 Minnesota Corporate Finance Conference, the 2010 SED Meetings, and the 2011 North American Winter Meetings of the Econometric Society, although we remain responsible for any errors, omissions, or typos. Luis Bryce provided excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Michael J. Fishman & Jonathan A. Parker, 2015. "Valuation, Adverse Selection, and Market Collapses," Review of Financial Studies, vol 28(9), pages 2575-2607. citation courtesy of