Contagious Adverse Selection
نویسندگان
چکیده
We illustrate the corrosive e¤ect of even small amounts of adverse selection in an asset market and how it can lead to the total breakdown of trade. The problem is the failure of market con dence, de ned as approximate common knowledge of an upper bound on expected losses. Small probability events can unravel market con dence. We discuss the role of contagious adverse selection and the problem of toxic assetsin the recent nancial crisis. We are grateful to Christian Hellwig for his discussion of this paper at the University of Michigan November 2009 conference on "The Financial Crisis: Lessons for Economic Theory." We are also grateful for comments from other participants at the Michigan conference, Markus Brunnermeier and other participants at the Princeton Departmentwide seminar in October 2008.
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