Adverse selection and self-fulfilling business cycles

Jess Benhabib, Feng Dong, Pengfei Wang

    Research output: Contribution to journalArticle

    Abstract

    This paper introduces a simple adverse selection problem arising in credit markets into a standard textbook continuous-time real business cycle model. Such adverse selection generates multiple steady states and both local and global indeterminacy, and can give rise to equilibria with probabilistic jumps in credit, consumption, investment and employment driven by Markov sunspots under calibrated parameterizations and fully rational expectations. Introducing reputational effects eliminates defaults and results in a unique but still indeterminate steady state. Finally we generalize the model to firms with heterogeneous and stochastic productivity, and show that indeterminacies and sunspots persist.

    Original languageEnglish (US)
    JournalJournal of Monetary Economics
    DOIs
    StateAccepted/In press - Jan 1 2018

    Fingerprint

    Sunspots
    Business cycles
    Adverse selection
    Indeterminacy
    Multiple steady states
    Textbooks
    Credit markets
    Continuous time
    Credit
    Rational expectations
    Productivity
    Real business cycle models
    Jump

    Keywords

    • Adverse selection
    • Global dynamics
    • Local indeterminacy
    • Sunspots

    ASJC Scopus subject areas

    • Finance
    • Economics and Econometrics

    Cite this

    Adverse selection and self-fulfilling business cycles. / Benhabib, Jess; Dong, Feng; Wang, Pengfei.

    In: Journal of Monetary Economics, 01.01.2018.

    Research output: Contribution to journalArticle

    Benhabib, Jess ; Dong, Feng ; Wang, Pengfei. / Adverse selection and self-fulfilling business cycles. In: Journal of Monetary Economics. 2018.
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