DP11408 Runs versus Lemons: Information Disclosure and Fiscal Capacity

Author(s): Miguel Faria-e-Castro, Joseba Martinez, Thomas Philippon
Publication Date: July 2016
Keyword(s):
JEL(s): E5, E6, G1, G2
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11408

We study the optimal use of disclosure and fiscal backstops during financial crises. Providing information can reduce adverse selection in credit markets, but negative disclosures can also trigger inefficient bank runs. In our model governments are thus forced to choose between runs and lemons. A fiscal backstop mitigates the risk of runs and allows a government to pursue a high disclosure strategy. Our model explains why governments with strong fiscal positions are more likely to run informative stress tests, and, paradoxically, how they can end up spending less than governments that are more fiscally constrained.