Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/211939 
Year of Publication: 
2003
Series/Report no.: 
Bank of Finland Discussion Papers No. 6/2003
Publisher: 
Bank of Finland, Helsinki
Abstract: 
We study a financial market adverse selection model where all agents are endowed with initial wealth and choose to invest as entrepreneurs or financiers, or not to invest.We show that often a lack of outside finance leads to the emergence of financial markets where availability of outside finance leads to autarky.We find that i) there exist Pareto-efficient and inefficient equilibria; ii) adverse selection has more severe consequences for poorer economies; iii) increasing initial wealth may cause a shift from Pareto-efficient to inefficient equilibrium; iv) increasing the proportion of agents with positive NPV projects causes a shift from inefficient to efficient equilibrium; v) equilibrium financial contracts are either equity-like or 'pure' debt contracts; vi) agents with negative (positive) NPV projects earn rents only in (non-)wealth-constrained economies; vii) agents earn rents only when employing pure debt contracts; and viii) removing storage technology destroys the only Pareto-efficient equilibrium in non-wealth-constrained economies.Our model enables analysis of various policies concerning financial stability, the need for sophisticated financial institutions, development aid, and the promotion of entrepreneurship.
Subjects: 
financial market efficiency
adverse selection
financial contracts
creation of firms
JEL: 
D58
G14
G20
G28
G32
Persistent Identifier of the first edition: 
ISBN: 
952-462-039-1
Document Type: 
Working Paper

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