Chapter 8: Q.11 (page 235)
How can asymmetric information problems lead to a bank panic?
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What steps can the government take to reduce asymmetric information problems and help the financial system function more smoothly and efficiently?
Go to the St. Louis Federal Reserve FRED database and find data on net worth of households (TNWBSHNO) and the net percentage of domestic banks tightening standards for auto loans (STDSAUTO). Adjust the units setting for the net worth indicator to “Percent Change from Year Ago,” and download the data into a spreadsheet.
a. Calculate the average, over the most recent four quarters and the four quarters prior to that, for the bank standards indicator and the “percent change in net worth” indicator. Do these averages behave as you would expect?
b. Use the Data Analysis tool in Excel to calculate the correlation coefficient for the two data series from 2011:Q2 to the most recent quarter of data available. What can you conclude about the relationship between the net worth of households and bank auto lending standards? Is this result consistent with efforts to reduce asymmetric information?
Suppose you go to your local bank, intending to buy a certificate of deposit with your savings. Explain why you would prefer this to offering a loan, at an interest rate that is higher than the rate the bank pays on certificates of deposit (but lower than the rate the bank charges for car loans), to the next individual who enters the bank and applies for a car loan.
You are in the market for a used car. At a used car lot, you know that the Blue Book value of the car you are looking at is between \(15000 and \)19000. If you believe the dealer knows as much about the car as you do, how much are you willing to pay? Why? Assume that you care only about the expected value of the car you will buy and that the car values are symmetrically distributed.
You own a house worth $800,000 that is located on a river bank. If the river floods moderately, the house will be completely destroyed. This happens about once every 50 years. If you build a seawall, the river would have to flood heavily to destroy your house, which only happens about once every 200 years. What would be the annual premium for a flood insurance policy that offers full insurance? For a policy that pays only 70% of the home value, what are your expected costs with and without a seawall? Do the different policies provide an incentive to be safer (i.e., to build the seawall) ?
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