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Risk Rationing and Activity Choice in Moral Hazard Constrained Credit Markets

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Author Info
Boucher, Stephen (U of California, Davis)
Carter, Michael R. (U of Wisconsin)
Abstract

This paper explores the productivity and income distribution e.ects of asymmetric information and risk preferences on the credit market. A model of contract design in the presence of moral hazard is developed in which competitive, risk neutral lenders o.er contracts to risk averse agents who hold the option to invest capital and labor time in an entrepreneurial activity. The model gives rise to the potential for quantity rationing and an additional form of non-price rationing called risk rationing. Both quantity and risk rationed agents would seek credit and carry out the entrepreneurial activity in a first best, or symmetric information world. When information is asymmetric, the menu of available loan contracts shrinks. In equilibrium, neither type of agent ends up with a loan contract, and both undertake a safe, but low return wage labor activity. Quantity rationed agents are involuntarily excluded from the entrepreneurial activity because they are denied any loan contract. Risk rationed agents voluntarily retreat from the credit market and the entrepreneurial activity rather than choose among the limited set of high risk contracts available to them in the presence of asymmetric information. Analysis shows that both quantity and risk rationing are likely to be wealth-biased, inhibiting the activity choice and the income earning potential of low wealth agents, and reproducing initial inequality.

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Paper provided by University of Wisconsin, Agricultural and Applied Economics in its series Staff Paper Series with number 445.

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Date of creation: Oct 2001
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Handle: RePEc:ecl:wisagr:445

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D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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  1. Armendariz de Aghion, Beatriz, 1999. "On the design of a credit agreement with peer monitoring," Journal of Development Economics, Elsevier, vol. 60(1), pages 79-104, October. [Downloadable!] (restricted)
  2. Bell, Clive & Srinivasan, T N & Udry, Christopher, 1997. "Rationing, Spillover, and Interlinking in Credit Markets: The Case of Rural Punjab," Oxford Economic Papers, Oxford University Press, vol. 49(4), pages 557-85, October. [Downloadable!] (restricted)
  3. Besley, Timothy & Coate, Stephen, 1995. "Group lending, repayment incentives and social collateral," Journal of Development Economics, Elsevier, vol. 46(1), pages 1-18, February. [Downloadable!] (restricted)
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  4. Bardhan, Pranab & Bowles, Samuel & Gintis, Herbert, 2000. "Wealth inequality, wealth constraints and economic performance," Handbook of Income Distribution, in: A.B. Atkinson & F. Bourguignon (ed.), Handbook of Income Distribution, edition 1, volume 1, chapter 10, pages 541-603 Elsevier. [Downloadable!] (restricted)
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  5. Bell, Clive, 1990. "Interactions between Institutional and Informal Credit Agencies in Rural India," World Bank Economic Review, Oxford University Press, vol. 4(3), pages 297-327, September.
  6. Besley, Timothy, 1995. "Savings, credit and insurance," Handbook of Development Economics, in: Hollis Chenery† & T.N. Srinivasan (ed.), Handbook of Development Economics, edition 1, volume 3, chapter 36, pages 2123-2207 Elsevier. [Downloadable!] (restricted)
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  1. Craig McIntosh & Alain de Janvry & Elisabeth Sadoulet, 2003. "How Rising Competition Among Microfinance Lenders Affects Incumbent Village Banks," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series 987, Department of Agricultural & Resource Economics, UC Berkeley. [Downloadable!]
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