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Optimal debt contracts and moral hazard along the business cycle

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Author Info
Pietro Reichlin ()
Paolo Siconolfi

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Abstract

We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal “abilities” borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers’ ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations. Copyright Springer-Verlag Berlin/Heidelberg 2004

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File URL: http://hdl.handle.net/10.1007/s00199-003-0413-0
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Publisher Info
Article provided by Springer in its journal Economic Theory.

Volume (Year): 24 (2004)
Issue (Month): 1 (07)
Pages: 75-109
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Handle: RePEc:spr:joecth:v:24:y:2004:i:1:p:75-109

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Related research
Keywords: Financial intermediation; Asymmetric information; Business cycle.;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Suarez, Javier & Sussman, Oren, 1997. "Endogenous Cycles in a Stiglitz-Weiss Economy," CEPR Discussion Papers 1604, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Boyd, John H & Smith, Bruce D, 1993. "The Equilibrium Allocation of Investment Capital in the Presence of Adverse Selection and Costly State Verification," Economic Theory, Springer, vol. 3(3), pages 427-51, July.
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  3. Bester, Helmut, 1987. "The role of collateral in credit markets with imperfect information," European Economic Review, Elsevier, vol. 31(4), pages 887-899, June. [Downloadable!] (restricted)
  4. Reichlin, Pietro & Siconolfi, Paolo, 1997. "Adverse Selection of Investment Projects and the Business Cycle," CEPR Discussion Papers 1631, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
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  6. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  7. Bruce C. Greenwald & Joseph E. Stiglitz, 1993. "Financial Market Imperfections and Business Cycles," NBER Working Papers 2494, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March. [Downloadable!] (restricted)
  9. Caballero, Ricardo J & Hammour, Mohamad L, 1994. "The Cleansing Effect of Recessions," American Economic Review, American Economic Association, vol. 84(5), pages 1350-68, December. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Gunnar Bårdsen & Kjersti-Gro Lindquist & Dimitrios P. Tsomocos, 2006. "Evaluation of macroeconomic models for financial stability analysis," Working Paper Series 6806, Department of Economics, Norwegian University of Science and Technology. [Downloadable!]
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  2. Alberto Martin, 2004. "Endogenous Credit Cycles," Economics Working Papers 916, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2008. [Downloadable!]
  3. ATTAR, AndrŽa, 2003. "Financial contracting along the business cycle," CORE Discussion Papers 2003069, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
  4. Alberto Martin, 2009. "A Model of Collateral, Investment, and Adverse Selection," Economics Working Papers 1136, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
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