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Collateral and Credit Supply

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Author Info

  • Joseph Atta-Mensah

Abstract

The author examines the role of collateral in an environment where lenders and borrowers possess identical information and similar beliefs about its future value. Using option-pricing techniques, he shows that a secured loan contract is equivalent to a regular bond and an embedded option to the borrower to default. He finds that the lender will not advance to the borrower a loan that exceeds the market value of the collateral, and that the supply of loans increases with a rise in the market value of the collateral. Increases in the volatility of the value of the collateral, interest rate, and dividend rate of the collateral independently depress the loan supply. The author also derives the cost of a third-party guarantee of a loan and an implied risk premium.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp03-11.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 03-11.

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Length: 28 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:bca:bocawp:03-11

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Related research

Keywords: Credit and credit aggregates; Economic models;

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References

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  1. David Besanko & Anjan V. Thakor, 2004. "Competitive Equilibrium in the Credit Market under Asymmetric Information," Finance 0411045, EconWPA.
  2. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
  3. Barro, Robert J, 1976. "The Loan Market, Collateral, and Rates of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(4), pages 439-56, November.
  4. Allen N. Berger & Gregory F. Udell, 1988. "Collateral, loan quality, and bank risk," Finance and Economics Discussion Series 51, Board of Governors of the Federal Reserve System (U.S.).
  5. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September.
  6. Chan, Yuk-Shee & Kanatas, George, 1985. "Asymmetric Valuations and the Role of Collateral in Loan Agreements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(1), pages 84-95, February.
  7. Leeth, John D. & Scott, Jonathan A., 1989. "The Incidence of Secured Debt: Evidence from the Small Business Community," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 379-394, September.
  8. Black, Jane & de Meza, David & Jeffreys, David, 1996. "House Price, the Supply of Collateral and the Enterprise Economy," Economic Journal, Royal Economic Society, vol. 106(434), pages 60-75, January.
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