Collateral and Credit Supply
AbstractThe 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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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 03-11.
Length: 28 pages
Date of creation: 2003
Date of revision:
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Credit and credit aggregates; Economic models;
Find related papers by JEL classification:
- E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
- E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-05-08 (All new papers)
- NEP-CFN-2003-05-08 (Corporate Finance)
- NEP-FIN-2003-05-08 (Finance)
- NEP-MFD-2003-05-08 (Microfinance)
- NEP-RMG-2003-05-08 (Risk Management)
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.:
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"Collateral, loan quality, and bank risk,"
Finance and Economics Discussion Series
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Journal of Economic Theory,
Elsevier, vol. 42(1), pages 167-182, June.
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