DP10614 Runs versus Lemons: Information Disclosure and Fiscal Capacity

Author(s): Miguel Faria-e-Castro, Joseba Martinez, Thomas Philippon
Publication Date: May 2015
Keyword(s): bailouts, credit guarantees, deposit insurance, fiscal backstop, stress tests
JEL(s): E5, E6, G1, G2
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10614

We characterize the optimal use of information disclosure and fiscal backstops during financial crises. In our model, financial crises force governments to choose between runs and lemons. Revealing information about banks? assets reduces adverse selection in credit markets, but it can also create inefficient runs on weak banks. A fiscal backstop mitigates this risk and allows the government to pursue a high disclosure strategy. A government with a strong fiscal position is more likely to run informative stress tests than a government with a weak fiscal position. As a result, such a government is also less likely to rely on outright bailouts.