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Welfare-Improving Adverse Selection in Credit Markets

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  • James Vercammen

    (University of British Columbia, Canada)

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    Abstract

    A model of simultaneous adverse selection and moral hazard in a competitive credit market is developed and used to show that aggregate borrower welfare may be higher in the combined case than in the moral-hazard-only case. Adverse selection can be welfare improving because in the pooling equilibrium of the combined model, high-quality borrowers cross subsidize low-quality borrowers. The cross subsidization reduces the overall moral hazard effort effects, and the resulting gain in welfare may more than offset the welfare loss stemming from distorted investment choices. The analysis focuses on pooling equilibria because model structure precludes separating equilibria. Copyright 2002 by the Economics Department of the University of Pennsylvania and Osaka University Institute of Social and Economic Research Association

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    Bibliographic Info

    Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

    Volume (Year): 43 (2002)
    Issue (Month): 4 (November)
    Pages: 1017-1033

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    Handle: RePEc:ier:iecrev:v:43:y:2002:i:4:p:1017-1033

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    Cited by:
    1. Margherita Bottero & Giancarlo Spagnolo, 2013. "Limited credit records and market outcomes," Temi di discussione (Economic working papers) 903, Bank of Italy, Economic Research and International Relations Area.
    2. Daniel Gottlieb & Lucas Maestri, 2004. "Banning Information As A Redistributive Device," Anais do XXXII Encontro Nacional de Economia [Proceedings of the 32th Brazilian Economics Meeting] 046, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].

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