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BP Junior Faculty Chair, Tepper School of Business

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Screening and adverse selection in frictional markets

Ariel Zetlin-Jones' research focuses on macroeconomics, business cycles, financial frictions and banking. He examines what makes financial markets work and how to design optimal regulations for financial markets and institutions.

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Ariel Zetlin Jones, Tepper School Associate Professor of Economics, speaks about his research on what makes financial markets work.


Video Transcript: 

Ariel Zetlin Jones: I’m a macroeconomist with interest in financial markets, so most of my research is aimed at developing a better understanding of what makes financial markets work. And, importantly, how do we design the optimal regulations of financial markets and financial institutions.

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My paper, "Screening and Adverse Selection in Frictional Markets," focuses on the economics of information in competition and financial markets. In the wake of the financial crisis, there are a lot of policies intended to promote competition and/or transparency in financial markets. Basically, trying to make financial markets behave more competitive and make it easy for investors to know and understand prices in financial markets. 

And so, our question was are these necessarily good policies. So, we're thinking about markets for loans or credit, markets for insurance like healthcare, or even markets for just selling or transacting in financial securities. So, we think of these markets as being special because they're information friction. So, we usually think some agents know more information than others. So, in insurance, we might think of consumers knowing more about their healthcare risks than insurers. In the market for used cars, we might think of sellers of cars knowing more about the quality of their car than the potential buyer. And, when we think about these markets which have been studied for a long time, we might ask, should we promote more competition in these types of markets. Is this necessarily a good thing?

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What we want to do is adapt and develop these models, be able to study, kind of, imperfect competition at the same time. And, that had not been done. And so, we made some kind of novel, analytical insights that allow us to study a market with informational frictions and frictions to competition at the same time and understand how these markets work. 

And so, really, the contribution of our paper is developing a unified framework that can study the interplay between informational frictions and frictions to competition. So, among other findings, kind of the most important one we find is that in markets with informational frictions, increasing competition is not necessarily a good thing. The challenging part about understanding this result is that increasing competition impacts the way that purchasers of these securities might try to screen people with different quality assets. And, what we show is that increasing competition can actually lead to more screening. And, this additional screening that comes with more competition can be harmful to people trying to sell their securities and acquire liquidity.

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The bottom line is that in markets where there's lots and lots of market power, increasing competition can improve outcomes for all possible traders in this environment. But, when we already have some degree of market power, policies that spur additional competition can be harmful for not just the people who are trying to acquire the assets but even the people trying to sell the assets.

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Ariel Zetlin Jones: Do Consumers Benefit From More Competition in Financial Markets?

This elective course is offered to Undergraduate Economics students. The instructor is Ariel Zetlin-Jones, Associate Professor of Economics. Financial Crises and Risk provides an in-depth examination of the causes of financial crises as well as what governments can do to prevent them or at least reduce their cost.

Video Transcript: 

On a day-to-day basis, we all interact with financial markets of various kinds. Whether we're using our credit card, whether we're using our debit card issued by our bank, writing a check, we all use various instruments that financial markets create and/or buy insurance or other projects financial markets offer to us. So at a basic level, all of us are consumers of financial marketing institutions and everyone should understand what financial market institutions do and provide for consumers. 

And so we start by doing an in-depth analysis of how consumers make decisions under uncertainty. What we then do is apply all of this rich knowledge that builds again off of our economics training throughout our principles and intermediate courses to explain kind of the roles financial markets play and what data from financial markets can tell us about consumers. What we see is a lot of these roles come from the value added banks provide for consumers naturally exposes them to risk of collapse. Unfortunately, a lot of this risk of collapse seems to happen across a lot of banks at the same time within a given country or across multiple countries. And once we understand the tradeoffs involved, that banks create value for consumers, but they also are subject to their own risks, then we can start understanding better how policies are and should be designed to manage these risks. We need to know wages in the current future period and we need to know interest rates. 

I hope students walk away with a clear understanding of the roles financial markets play, both in their day-to-day lives and in the broader society, and I hope more than anything that they've learned another example of how to think about the tradeoffs involved with particular economic policies or individual choices they're making in a much more complicated environment. Since the financial crisis, there's massive amounts of innovation going on in the financial market space, so I would also say innovators should really be interested in financial crisis. So we think about cryptocurrencies and how that's reshaping financial markets, we think about lots of other innovations in Fintech. And if you want to understand kind of what are the roles that traditional financial institutions like banks play, and understand where there's space for innovation, and interesting, exciting opportunities to create value for society, this is a course that you should be taking.

Financial Crises and Risk Undergraduate Economics Course with Ariel Zetlin Jones

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