Adverse selection and moral hazard: Quantitative implications for unemployment insurance

A model of optimal unemployment insurance with adverse selection and moral hazard is constructed. The model generates both qualitative and quantitative implications for the optimal provision of unemployment insurance. Qualitatively, for some agents, incentives in the optimal contract imply consumption increases over the duration of non-employment. Calibrating the model to a stylized version of the U.S. economy quantitatively illustrates these theoretical predictions. The optimal contract achieves a welfare gain of 1.94% relative to the current U.S. system, an additional 0.87% of gains relative to a planner who ignores adverse selection and focuses only on moral hazard.     

Securitization and moral hazard: Evidence from credit score cutoff rules

A growing literature exploits credit score cutoff rules as a natural experiment to estimate the moral hazard effect of securitization on lender screening. However, these cutoff rules can be traced to underwriting guidelines for originators, not for securitizers. Moreover, loan-level data reveal that lenders change their screening at credit score cutoffs in the absence of changes in the probability of securitization. Credit score cutoff rules thus cannot be used to learn about the moral hazard effect of securitization on underwriting. By showing that this evidence has been misinterpreted, our analysis should move beliefs away from the conclusion that securitization led to lax screening.     

Non-performing loans,moral hazard and regulation of the Chinese commercial banking system

Non-performing loans (NPLs) represent a major obstacle to the development of banking sector. One of the key objectives of the banking sector reforms in China has therefore been to reduce the high level of NPLs. To do so, Chinese regulatory authorities have injected significant capital into the banking system and scrutinized NPLs since 2003. This paper examines the impact of NPLs on bank behavior in China. Using a threshold panel regression model and a dataset covering 60 city commercial banks, 16 state-owned banks and joint-stock banks, and 11 rural commercial banks during 2006–2012, we test whether lending decisions of Chinese banks exhibit moral hazard. The results support the moral hazard hypothesis, suggesting that an increase in the NPLs ratio raises riskier lending, potentially causing further deterioration of the loan quality and financial system instability. Policy implications of findings are evaluated.     

Redistributive taxation and social insurance under adverse selection in the insurance market

This paper extends the analysis of optimal income taxation under uncertainty studied by Cremer and Pestieau (International Tax and Public Finance, 3, 281–295, 1996). We introduce asymmetric information in the insurance market whereby private insurance companies cannot identify the risk probability of the agents, and we examine its effect on public policy. We consider the separating equilibrium of Rothschild and Stiglitz (Quarterly Journal of Economics, 90, 629–649, 1976) and Riley (Econometrica, 47, 331–359, 1979) where the low risk agent is only partially insured. The presence of the distortion in the insurance market changes the affinity of labor, and in some cases, we show that the scope of redistribution and the resulting social welfare are higher under asymmetric information than under full information. We also show that the increase in social insurance affects the utility and labor incentive of the low risk type by relaxing the self-selection constraint in the insurance market. The policy implications of the redistributive taxation and social insurance are analytically and numerically examined.      

Finance and inequality: The distributional impacts of bank credit rationing

We analyze reductions in bank credit using a natural experiment where unprecedented flooding in Pakistan differentially affected banks that were more exposed to the floods. Using a unique data set that covers the universe of consumer loans in Pakistan and this exogenous shock to bank funding, we find two key results. First, following an increase in their funding costs, banks disproportionately reduce credit to borrowers with little education, little credit history, and seasonal occupations. Second, the credit reduction is not compensated by relatively more lending by less-affected banks. The empirical evidence suggests that a reduction in bank monitoring incentives caused the large relative decreases in lending to these borrowers.     

Syndicated loan spreads and the composition of the syndicate

During the past decade, non-bank institutional investors are increasingly taking larger roles in the corporate lending than they historically have played. These non-bank institutional lenders typically have higher required rates of return than banks, but invest in the same loan facilities. In a sample of 20,031 leveraged loan facilities originated between 1997 and 2007, facilities including a non-bank institution in their syndicates have higher spreads than otherwise identical bank-only facilities. Contrary to risk-based explanations of this finding, non-bank facilities are priced with premiums relative to bank-only facilities in the same loan package. These non-bank premiums are substantially larger when a hedge or private equity fund is one of the syndicate members. Consistent with the notion that firms are willing to pay a premium when loan facilities are particularly important to them, the non-bank premiums are larger when borrowing firms face financial constraints and when capital is less available from banks.     

Collateralization of business loans: Testing the prediction of theories

Using confidential data on a large sample of relationship lending, we analyze the determining factors of the collateralization of business loans from banks, distinguishing between firms with observable risk and firms with hidden information. We achieve three main results. First, we provide evidence that observably riskier borrowers are encouraged to give more collateral to banks to obtain a loan, whereas firms with hidden information are less risky borrowers, offering collateral to signal their quality. Second, we show that relationship banking has a direct impact on the use of collateral and produces moderating effects on the other determining factors. Finally, we observe that distant bank branches—i.e., branches that encounter greater difficulties collecting soft information and obtaining site-specific data from headquarters—are more likely to require collateral than local bank branches.     

Adverse selection in the annuity market with sequential and simultaneous insurance demand

This paper investigates the effect of adverse selection on the private annuity market in a model with two periods of retirement and two types of individuals, who differ in their life expectancy. In order to introduce the existence of time-limited pension insurance, we consider a model where for each period of retirement separate contracts can be purchased. Demand for the two periods can be decided sequentially or simultaneously. We show that only a situation where all risk types choose sequential contracts is an equilibrium and that this outcome is favourable for the long-living, but is unfavourable for the short-living individuals. JEL Classification D82 · D91 · G22     

The effects of government capital and liquidity support programs on bank lending: Evidence from the syndicated corporate credit market

This study jointly evaluates the effects of the U.S. Treasury's Troubled Asset Relief Program (TARP), the Federal Reserve's Discount Window (DW), and Term Auction Facility (TAF) on bank syndicated lending during the 2007–2009 financial crisis, using a unique data set that tracks the exposure of each lender in each syndicated credit facility in each year. By comparing lending changes within a group of banks that lend to the same facility of the same firm in the same year, it eliminates the impacts of demand-side factors that often bias the results of empirical studies on bank credit supply. Overall, I find that TARP, DW, and TAF played only a marginal role in increasing bank syndicated lending. By examining lending changes at the facility-lender and firm-lender levels, this study is less prone to the reverse causality problem that is inherent in studies using bank-level data. Therefore, this study complements studies using bank-level data and provides policymakers with a balanced view on the effects of these programs.     

City goes dark: Dark trading and adverse selection in aggregate markets

We investigate the impact of dark trading on adverse selection in an aggregate market for trading UK stocks. Dark trading is linked to lower adverse selection risk and improved informational efficiency and liquidity in the aggregate market, even as liquidity declines in the lit market with dark trading. However, there is a trading value-based threshold when dark trading starts to induce adverse selection. We estimate that this threshold varies from around 9% for the most liquid stocks to 25% for the least liquid stocks. The overall average threshold for the 288 FTSE 350 stocks in our sample is 14%.     

我国企业年金逆向选择和道德风险管理研究

当前形势下我国人口老龄化问题日益凸显,基本养老保险制度面临着巨大的支付压力。企业年金在缓解基本养老保险给付方面起到了重大的补充作用,但是我国现行的企业年金在实际运营管理中存在很多问题。论文从委托代理角度分析企业年金各主体之间的逆向选择和道德风险问题,并提出几点相关政策建议,以完善我国企业年金制度,使其更好地为企业职工提供更安全更实惠的社会福利。     

保险市场逆向选择与顺向选择共存研究

保险市场存在着逆向选择。经典逆向选择模型认为,风险高的人会购买更多的保险,但大多数实证研究表明保险市场还存在顺向选择。本文认为,逆向选择和顺向选择虽然对立,但共存于保险市场,在此基础上构建保险市场均衡模型,并进行了仿真研究。     

Debt contracts and collapse as competition phenomena

We study financial intermediation in which sufficient sorting is impossible. We identify a new type of market failure that may occur even when returns of investing entrepreneurs are verifiable. Moreover, we suggest that the nature of competition determines the contracts banks offer. A monopoly bank will offer equity contracts. In any pure strategy equilibrium when lenders compete à la Bertrand, however, only debt contracts are offered.     

The seeds of a crisis: A theory of bank liquidity and risk taking over the business cycle

We examine how the banking sector could ignite the formation of asset price bubbles when there is access to abundant liquidity. Inside banks, to induce effort, loan officers are compensated based on the volume of loans. Volume-based compensation also induces greater risk taking; however, due to lack of commitment, loan officers are penalized ex post only if banks suffer a high enough liquidity shortfall. Outside banks, when there is heightened macroeconomic risk, investors reduce direct investment and hold more bank deposits. This ‘flight to quality’ leaves banks flush with liquidity, lowering the sensitivity of bankers’ payoffs to downside risks and inducing excessive credit volume and asset price bubbles. The seeds of a crisis are thus sown.     

Surety bonds and moral hazard in banking

We examine a policy in which owners of banks provide funds in the form of a surety bond in addition to equity capital. This policy would require banks to provide the regulator with funds that could be invested in marketable securities. Investors in the bank receive the income from the surety bond as long as the bank is in business. The capital value could be used by bank regulators to pay off the banks’ liabilities in case of bank failure. After paying depositors, investors would receive the remaining funds, if any. Analytically, this instrument is a way of creating charter value but, as opposed to Keeley (1990) and Hellman, Murdock and Stiglitz (2000), restrictions on competition are not necessary to generate positive rents. We demonstrate that capital requirements alone cannot prevent the moral hazard problem arising from deposit insurance.     

Voluntary disclosure and adverse selection: Bayesian game theoretical inference for green bond labelling regimes

The impact finance market has sought to ‘internalise externalities and adjust risk perceptions’ (G20 Green Finance Study Group, 2016), demonstrating the private sector’s capability in resolving the climate free-rider problem through the ‘greening’ of economic activities, partially bypassing corrective government intervention. As the market continues to develop, however, the voluntary disclosure regime that the market operates under threatens to enforce an adverse selection problem and contribute to a fundamental erosion of confidence in the market segment, constraining the potential of impact finance instruments to effect positive social and environmental change. This paper relates the work of Crawford and Sobel (1982), Milgrom (1981), Verrecchia (1983), Jung and Kwon (1988), Myers and Majluf (1984) to the green bond market and draws inferences to inform recommendations for policy-led solutions aimed at ensuring the alignment of green bonds’ proceeds to the interests of society (desirable outcomes within the scope of the Paris agreement, for example) and upholding the market’s credibility. This paper additionally explores the transplantation of sustainability linker mechanisms into green bond architecture to ensure simultaneous issuer-level alignment.     

完全信息状态下保险市场主体间的静态博弈研究

保险市场主体的行为以及他们之间的复杂关系直接影响着保险市场的发展,特别是投保人的逆向选择、道德风险和保险代理人的违规操作广泛存在,长期困扰着保险界。本文针对投保人和保险代理人的问题行为,通过建立完全信息静态博弈模型,来深入研究保险人与投保人、保险代理人之间的博弈关系,探讨解决问题的现实对策。     

Institutions,moral hazard and expected government support of banks

We model the expected support of banks with credit ratings from Moody's and Fitch, taking explicitly into account the capacity and willingness of governments to provide support in case of need, as well as their concerns about moral hazard (i.e., that the expected support may induce banks to assume bigger risks). Our results suggest that moral hazard concerns are relatively weak. In addition, a substantial part of the expected support can be attributed to the quality of a country's institutions. These findings have important implications for the dynamics of banking crises, the value of the ‘fair’ insurance premium banks might be called upon to pay for the expected support, as well as for ways to reduce the resulting negative externalities.     

A model of a systemic bank run

This paper provides a model of the view that the 2008 financial crisis is reminiscent of a bank run, focussing on six stylized key features. In particular, core financial institutions have invested their funds in asset-backed securities rather than committed to long-term projects: in distress, these can potentially be sold to a large pool of outside investors at steep discounts. I consider two different motives for outside investors and their interaction with banks trading asset-backed securities: uncertainty aversion versus adverse selection. I shall argue that the version with uncertainty averse investors is more consistent with the stylized facts than the adverse selection perspective: in the former, the crisis deepens, the larger the market share of distressed core banks, while a run becomes less likely instead as a result in the adverse selection version. Therefore, the outright purchase of troubled assets by the government at prices above current market prices may both alleviate the financial crises as well as provide tax payers with returns above those for safe securities.