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Asymmetric information in credit markets and entrepreneurial risk taking

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  • Vesala , Timo

    (RUESG, , University of Helsinki)

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    Abstract

    The paper constructs a search-theoretic model of credit markets with a bilateral trading mechanism that enables the manageable introduction of asymmetric information. Borrowers´ success probabilities are unobservable to financiers, but the degree of risk in observable projects can be used as a sorting device. We find that the efficiency of a perfect Bayesian equilibrium depends negatively/positively on the credit market ´tightness´/liquidity. In general equilibrium, where the underlying market conditions are endogenously determined, steady states with greater credit market tightness are always associated with increasingly excessive investment in risky projects. Since tighter market conditions also imply less intense competition among financiers, the commonly asserted trade-off between competition and efficiency does not emerge. Tighter monetary policy is shown to worsen the adverse effect of informational frictions on efficiency.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0414.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 14/2004.

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    Length: 35 pages
    Date of creation: 14 Jul 2004
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2004_014

    Contact details of provider:
    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: credit market; asymmetric information; search; risk taking;

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    References

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    1. Ariel Rubinstein, 2010. "Perfect Equilibrium in a Bargaining Model," Levine's Working Paper Archive 661465000000000387, David K. Levine.
    2. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 75(4), pages 850-55, September.
    3. Takalo, Tuomas & Toivanen, Otto, 2003. "Equilibrium in financial markets with adverse selection," Research Discussion Papers, Bank of Finland 6/2003, Bank of Finland.
    4. Thorsten Beck & Asli Demirguc-Kunt & Ross Levine, 2003. "Bank Concentration and Crises," NBER Working Papers 9921, National Bureau of Economic Research, Inc.
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    12. Franklin Allen & Douglas Gale, 2004. "Competition and financial stability," Proceedings, Federal Reserve Bank of Cleveland, pages 453-486.
    13. Zsolt Becsi & Victor Li & Ping Wang, 2000. "Financial matchmakers in credit markets with heterogeneous borrowers," Working Paper, Federal Reserve Bank of Atlanta 2000-14, Federal Reserve Bank of Atlanta.
    14. Kanniainen, Vesa & Leppämäki, Mikko, 2002. "Financial institutions and the allocation of talent," Research Discussion Papers, Bank of Finland 5/2002, Bank of Finland.
    15. Diamond, Peter, 1990. "Pairwise Credit in Search Equilibrium," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(2), pages 285-319, May.
    16. David de Meza, 2002. "Overlending?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 112(477), pages F17-F31, February.
    17. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1177, C.E.P.R. Discussion Papers.
    18. Muthoo,Abhinay, 1999. "Bargaining Theory with Applications," Cambridge Books, Cambridge University Press, number 9780521576475, 9.
    19. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, Econometric Society, vol. 58(2), pages 429-52, March.
    20. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, American Economic Association, vol. 79(1), pages 14-31, March.
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