Asset Quality Cycles∗
نویسندگان
چکیده
Systemic risk builds up endogenously during booms in an economy featuring asymmetric information in asset markets, where investors’ hidden effort choices determine asset quality distribution. Higher asset prices in booms induce more investors to sell their assets, which lowers their incentive to improve quality. This quality deterioration in turn makes the economy vulnerable to future exogenous shocks because market breakdowns become more likely. Private agents do not internalize the fact that their effort choices worsen future adverse selection problems, and thus the planner may improve welfare by taxing trade and thereby lowering asset prices.
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