Are adverse selection models of debt robust to changes in market structure?
AbstractMany adverse selection models of standard one-period debt contracts are based on the following seemingly innocuous assumptions. First, entrepreneurs have private information about the quality of their return distributions. Second, return distributions are ordered by the monotone likelihood-ratio property. Third, financiers’ payoff functions are restricted to be monotonically non-decreasing in firm profits. Fourth, financial markets are competitive. We argue that debt is not an optimal contract in these models if there is only one (monopoly) financier rather than an infinite number of competitive financiers.
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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 28/2003.
Length: 34 pages
Date of creation: 11 Nov 2003
Date of revision:
security design; adverse selection; monotonic contracts; monotone likelihood ratio; first-order stochastic dominance;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
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