DP10614 Runs versus Lemons: Information Disclosure and Fiscal Capacity
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.