Credit Markets with Asymmetric Information (Lecture Notes in by Gerhard Clemenz

By Gerhard Clemenz

Publication through Clemenz, Gerhard

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Additional resources for Credit Markets with Asymmetric Information (Lecture Notes in Economics and Mathematical Systems)

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A more natural assumption seems to be that there exists a spot market for new entrants and a market for implicit contracts for old customers. But if this is so, what is going to prevent an old customer from switching banks if the spot market rate is favourable? He is not risking anything since in the next period he would be an "old" customer anyway, that is a properly screened applicant with an account. Hence it seems doubtful that the implicit contract approach is really going to work. But it points to an aspect which is very important in a credit market, and which has already been emphasized in the joint production model of the previous section: The importance of a special relationship between a bank and its customers.

Higher iso-profit curves indicate higher expected profits. The line connecting all points (R,L), at which dRP/dL = 0 is denoted by Lt, i=l,2, and is called by Jaffee and NodigliaDi the monopolistic bank's supply curve. Consequently, the intersections of Lt and LD are called the market clearing interest factors HI. They are not, however, the bank-optimal interest rates. These are given at the tangency point of LD and Pi, denoted as Rf where the highest feasible iso-profit curves of the bank are reached, given LD as the relevant constraint of the optimization problem of the bank.

This could happen if the probability of default is an increasing function of r, and if this negative effect of raising r outweighs its positive effect on p. In this section it is shown more precisely how the non- monotonicity of p with respect to r creates the possibility of equilibrium credit rationing. The following sections present various mechanisms, based on asymmetric information implying adverse selection and moral hazard, which may induce the existence of a "bank-optimal" loan rate where p reaches a maximum.

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