Dysfunctional Finance : Positive Shocks and Negative Outcomes

This paper shows how badly a market economy may respond to a positive productivity shock in an environment with asymmetric information about project quality: some, all, or even more than all the benefits from the increase in productivity may be dis...

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Main Author:	Hoff, Karla
Format:	Policy Research Working Paper
Language:	English
Published:	2012
Subjects:	ACCESS TO CREDIT ADVERSE SELECTION ALTERNATIVE USE ASYMMETRIC INFORMATION BANKRUPTCY BANKRUPTCY LAWS BANKS BARRIERS TO ENTRY BONDS BORROWER BUSINESS CYCLES CAPITAL MARKET CARTEL COLLATERAL DEBT DEBT CONTRACT DEBT FINANCE DEFAULT PROBABILITY DEFAULTS DEMAND FOR CAPITAL DEMAND FOR FUNDS DEVELOPING COUNTRIES DEVELOPMENT ECONOMICS DISTRIBUTION OF INCOME DISTRIBUTION OF WEALTH ECONOMIC DEVELOPMENT ECONOMIC GROWTH ECONOMIC PERFORMANCE ECONOMIC STRUCTURE ECONOMIC THEORY ENTREPRENEUR ENTREPRENEURS EQUILIBRIUM EXPECTED RETURN EXPECTED VALUE EXTERNALITIES EXTERNALITY FAIR FINANCIAL FRAGILITY FINANCIAL INTERMEDIARIES FINANCIAL MARKET FINANCIAL MARKETS FINANCIAL SECTOR FIXED COST FRAUDS HOLDING IMPLICIT SUBSIDY INCOME INCOMPLETE MARKETS INDIFFERENCE CURVES INDUSTRIALIZATION INEQUALITY INFORMATIONAL ASYMMETRIES INTEREST RATE INTEREST RATE DECLINES INTERNATIONAL BANK INTERNATIONAL CAPITAL INTERNATIONAL CAPITAL MARKETS INTERNATIONAL ECONOMICS INTERNATIONAL FINANCIAL MARKET INVESTMENT FINANCE INVESTMENT OPPORTUNITY INVESTMENT PROCESS INVESTMENT PROJECTS LEVEL OF DEBT LIMITED LIABILITY LOAN LYON MACROECONOMICS MARGINAL COST MARGINAL PRODUCTIVITY MARKET DEVELOPMENT MARKET ECONOMY MARKET EQUILIBRIUM MARKET FAILURE MARKET INTEREST RATE MARKET MECHANISM NASH EQUILIBRIUM NEGATIVE SHOCK NEW ENTRANTS PERFECT COMPETITION POLITICAL ECONOMY PRODUCTIVITY PURE DEBT RAILROAD SECURITIES RETURN RETURNS SECONDARY MARKET SELF-FINANCE SHAREHOLDERS STOCK EXCHANGE STOCK EXCHANGES STOCKS SURPLUS TRADE POLICIES WEALTH
Online Access:	http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000333038_20100203233222 http://hdl.handle.net/10986/3701

id	okr-10986-3701
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spelling	okr-10986-37012021-04-23T14:02:12Z Dysfunctional Finance : Positive Shocks and Negative Outcomes Hoff, Karla ACCESS TO CREDIT ADVERSE SELECTION ALTERNATIVE USE ASYMMETRIC INFORMATION BANKRUPTCY BANKRUPTCY LAWS BANKS BARRIERS TO ENTRY BONDS BORROWER BUSINESS CYCLES CAPITAL MARKET CARTEL COLLATERAL DEBT DEBT CONTRACT DEBT FINANCE DEFAULT PROBABILITY DEFAULTS DEMAND FOR CAPITAL DEMAND FOR FUNDS DEVELOPING COUNTRIES DEVELOPMENT ECONOMICS DISTRIBUTION OF INCOME DISTRIBUTION OF WEALTH ECONOMIC DEVELOPMENT ECONOMIC GROWTH ECONOMIC PERFORMANCE ECONOMIC STRUCTURE ECONOMIC THEORY ENTREPRENEUR ENTREPRENEURS EQUILIBRIUM EXPECTED RETURN EXPECTED VALUE EXTERNALITIES EXTERNALITY FAIR FINANCIAL FRAGILITY FINANCIAL INTERMEDIARIES FINANCIAL MARKET FINANCIAL MARKETS FINANCIAL SECTOR FIXED COST FRAUDS HOLDING IMPLICIT SUBSIDY INCOME INCOMPLETE MARKETS INDIFFERENCE CURVES INDUSTRIALIZATION INEQUALITY INFORMATIONAL ASYMMETRIES INTEREST RATE INTEREST RATE DECLINES INTERNATIONAL BANK INTERNATIONAL CAPITAL INTERNATIONAL CAPITAL MARKETS INTERNATIONAL ECONOMICS INTERNATIONAL FINANCIAL MARKET INVESTMENT FINANCE INVESTMENT OPPORTUNITY INVESTMENT PROCESS INVESTMENT PROJECTS LEVEL OF DEBT LIMITED LIABILITY LOAN LYON MACROECONOMICS MARGINAL COST MARGINAL PRODUCTIVITY MARKET DEVELOPMENT MARKET ECONOMY MARKET EQUILIBRIUM MARKET FAILURE MARKET INTEREST RATE MARKET MECHANISM NASH EQUILIBRIUM NEGATIVE SHOCK NEW ENTRANTS PERFECT COMPETITION POLITICAL ECONOMY PRODUCTIVITY PURE DEBT RAILROAD SECURITIES RETURN RETURNS SECONDARY MARKET SELF-FINANCE SHAREHOLDERS STOCK EXCHANGE STOCK EXCHANGES STOCKS SURPLUS TRADE POLICIES WEALTH This paper shows how badly a market economy may respond to a positive productivity shock in an environment with asymmetric information about project quality: some, all, or even more than all the benefits from the increase in productivity may be dissipated. In the model, based on Bernanke and Gertler (1990), entrepreneurs with a low default probability are charged the same interest rate as entrepreneurs with a high default probability. The implicit subsidy from good types to bad means that the marginal entrant will have a negative-value project. An example is presented in which, after a positive productivity shock, the presence of enough bad type's forces the interest rate so high that it drives all entrepreneurs out of the market. This happens in an industry in which there are good projects that are productive. The problem is that they are contaminated in the capital market by bad projects because of the banks inability to distinguish good projects from bad. One possible explanation for the lack of development in some countries is that screening institutions are sufficiently weak that impersonal financial markets cannot function. If industrialization entails learning spillovers concentrated within national boundaries, and if initially informational asymmetries are sufficiently great that the capital market does not emerge, then neither industrialization nor the learning that it would foster will occur. 2012-03-19T18:38:09Z 2012-03-19T18:38:09Z 2010-01-01 http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000333038_20100203233222 http://hdl.handle.net/10986/3701 English Policy Research working paper ; no. WPS 5183 CC BY 3.0 IGO http://creativecommons.org/licenses/by/3.0/igo/ World Bank Publications & Research :: Policy Research Working Paper The World Region The World Region
repository_type	Digital Repository
institution_category	Foreign Institution
institution	Digital Repositories
building	World Bank Open Knowledge Repository
collection	World Bank
language	English
topic	ACCESS TO CREDIT ADVERSE SELECTION ALTERNATIVE USE ASYMMETRIC INFORMATION BANKRUPTCY BANKRUPTCY LAWS BANKS BARRIERS TO ENTRY BONDS BORROWER BUSINESS CYCLES CAPITAL MARKET CARTEL COLLATERAL DEBT DEBT CONTRACT DEBT FINANCE DEFAULT PROBABILITY DEFAULTS DEMAND FOR CAPITAL DEMAND FOR FUNDS DEVELOPING COUNTRIES DEVELOPMENT ECONOMICS DISTRIBUTION OF INCOME DISTRIBUTION OF WEALTH ECONOMIC DEVELOPMENT ECONOMIC GROWTH ECONOMIC PERFORMANCE ECONOMIC STRUCTURE ECONOMIC THEORY ENTREPRENEUR ENTREPRENEURS EQUILIBRIUM EXPECTED RETURN EXPECTED VALUE EXTERNALITIES EXTERNALITY FAIR FINANCIAL FRAGILITY FINANCIAL INTERMEDIARIES FINANCIAL MARKET FINANCIAL MARKETS FINANCIAL SECTOR FIXED COST FRAUDS HOLDING IMPLICIT SUBSIDY INCOME INCOMPLETE MARKETS INDIFFERENCE CURVES INDUSTRIALIZATION INEQUALITY INFORMATIONAL ASYMMETRIES INTEREST RATE INTEREST RATE DECLINES INTERNATIONAL BANK INTERNATIONAL CAPITAL INTERNATIONAL CAPITAL MARKETS INTERNATIONAL ECONOMICS INTERNATIONAL FINANCIAL MARKET INVESTMENT FINANCE INVESTMENT OPPORTUNITY INVESTMENT PROCESS INVESTMENT PROJECTS LEVEL OF DEBT LIMITED LIABILITY LOAN LYON MACROECONOMICS MARGINAL COST MARGINAL PRODUCTIVITY MARKET DEVELOPMENT MARKET ECONOMY MARKET EQUILIBRIUM MARKET FAILURE MARKET INTEREST RATE MARKET MECHANISM NASH EQUILIBRIUM NEGATIVE SHOCK NEW ENTRANTS PERFECT COMPETITION POLITICAL ECONOMY PRODUCTIVITY PURE DEBT RAILROAD SECURITIES RETURN RETURNS SECONDARY MARKET SELF-FINANCE SHAREHOLDERS STOCK EXCHANGE STOCK EXCHANGES STOCKS SURPLUS TRADE POLICIES WEALTH
spellingShingle	ACCESS TO CREDIT ADVERSE SELECTION ALTERNATIVE USE ASYMMETRIC INFORMATION BANKRUPTCY BANKRUPTCY LAWS BANKS BARRIERS TO ENTRY BONDS BORROWER BUSINESS CYCLES CAPITAL MARKET CARTEL COLLATERAL DEBT DEBT CONTRACT DEBT FINANCE DEFAULT PROBABILITY DEFAULTS DEMAND FOR CAPITAL DEMAND FOR FUNDS DEVELOPING COUNTRIES DEVELOPMENT ECONOMICS DISTRIBUTION OF INCOME DISTRIBUTION OF WEALTH ECONOMIC DEVELOPMENT ECONOMIC GROWTH ECONOMIC PERFORMANCE ECONOMIC STRUCTURE ECONOMIC THEORY ENTREPRENEUR ENTREPRENEURS EQUILIBRIUM EXPECTED RETURN EXPECTED VALUE EXTERNALITIES EXTERNALITY FAIR FINANCIAL FRAGILITY FINANCIAL INTERMEDIARIES FINANCIAL MARKET FINANCIAL MARKETS FINANCIAL SECTOR FIXED COST FRAUDS HOLDING IMPLICIT SUBSIDY INCOME INCOMPLETE MARKETS INDIFFERENCE CURVES INDUSTRIALIZATION INEQUALITY INFORMATIONAL ASYMMETRIES INTEREST RATE INTEREST RATE DECLINES INTERNATIONAL BANK INTERNATIONAL CAPITAL INTERNATIONAL CAPITAL MARKETS INTERNATIONAL ECONOMICS INTERNATIONAL FINANCIAL MARKET INVESTMENT FINANCE INVESTMENT OPPORTUNITY INVESTMENT PROCESS INVESTMENT PROJECTS LEVEL OF DEBT LIMITED LIABILITY LOAN LYON MACROECONOMICS MARGINAL COST MARGINAL PRODUCTIVITY MARKET DEVELOPMENT MARKET ECONOMY MARKET EQUILIBRIUM MARKET FAILURE MARKET INTEREST RATE MARKET MECHANISM NASH EQUILIBRIUM NEGATIVE SHOCK NEW ENTRANTS PERFECT COMPETITION POLITICAL ECONOMY PRODUCTIVITY PURE DEBT RAILROAD SECURITIES RETURN RETURNS SECONDARY MARKET SELF-FINANCE SHAREHOLDERS STOCK EXCHANGE STOCK EXCHANGES STOCKS SURPLUS TRADE POLICIES WEALTH Hoff, Karla Dysfunctional Finance : Positive Shocks and Negative Outcomes
geographic_facet	The World Region The World Region
relation	Policy Research working paper ; no. WPS 5183
description	This paper shows how badly a market economy may respond to a positive productivity shock in an environment with asymmetric information about project quality: some, all, or even more than all the benefits from the increase in productivity may be dissipated. In the model, based on Bernanke and Gertler (1990), entrepreneurs with a low default probability are charged the same interest rate as entrepreneurs with a high default probability. The implicit subsidy from good types to bad means that the marginal entrant will have a negative-value project. An example is presented in which, after a positive productivity shock, the presence of enough bad type's forces the interest rate so high that it drives all entrepreneurs out of the market. This happens in an industry in which there are good projects that are productive. The problem is that they are contaminated in the capital market by bad projects because of the banks inability to distinguish good projects from bad. One possible explanation for the lack of development in some countries is that screening institutions are sufficiently weak that impersonal financial markets cannot function. If industrialization entails learning spillovers concentrated within national boundaries, and if initially informational asymmetries are sufficiently great that the capital market does not emerge, then neither industrialization nor the learning that it would foster will occur.
format	Publications & Research :: Policy Research Working Paper
author	Hoff, Karla
author_facet	Hoff, Karla
author_sort	Hoff, Karla
title	Dysfunctional Finance : Positive Shocks and Negative Outcomes
title_short	Dysfunctional Finance : Positive Shocks and Negative Outcomes
title_full	Dysfunctional Finance : Positive Shocks and Negative Outcomes
title_fullStr	Dysfunctional Finance : Positive Shocks and Negative Outcomes
title_full_unstemmed	Dysfunctional Finance : Positive Shocks and Negative Outcomes
title_sort	dysfunctional finance : positive shocks and negative outcomes
publishDate	2012
url	http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000333038_20100203233222 http://hdl.handle.net/10986/3701
_version_	1764387887088926720

Dysfunctional Finance : Positive Shocks and Negative Outcomes

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