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Moral hazard in the credit market when the collateral value is stochastic

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  • Niinimäki, Juha-Pekka

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    (Bank of Finland Research)

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    Abstract

    This theoretical paper explores the effects of costly and non-costly collateral on moral hazard, when collateral value may fluctuate. Given that all collateral is costly, stochastic collateral will entail the same positive incentive effects as nonstochastic collateral, provided the variation in collateral value is modest. If it is large, the incentive effects are smaller under stochastic collateral. With non-costly collateral, stochastic collateral entails positive incentive effects or no effects, if the variation in collateral value is modest. If it is large, the incentive effects may be positive or negative. Thus, collateral can increase moral hazard. The findings are related to the topical subprime crisis and the fluctuating value of real estate collateral.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/1022netti.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 22/2010.

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    Length: 24 pages
    Date of creation: 21 Dec 2010
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2010_022

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    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Keywords: banking; collateral; moral hazard; subprime lending;

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    1. Manove, Michael & Padilla, A Jorge & Pagano, Marco, 2001. "Collateral versus Project Screening: A Model of Lazy Banks," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 726-44, Winter.
    2. Bester, H., 1990. "The Role Of Collateral In A Model Of Debt Renegotiation," Papers 9060, Tilburg - Center for Economic Research.
    3. Gerhard Clemenz & Mona Ritthaler, 1992. "Credit markets with asymmetric information : a survey," Finnish Economic Papers, Finnish Economic Association, vol. 5(1), pages 12-26, Spring.
    4. Erik Lehmann & Doris Neuberger & Solvig R”thke, 2004. "Lending to Small and Medium-Sized Firms: Is There an East-West Gap in Germany?," Small Business Economics, Springer, vol. 23(1), pages 23-39, 08.
    5. Esa Jokivuolle & Samu Peura, 2003. "Incorporating Collateral Value Uncertainty in Loss Given Default Estimates and Loan-to-value Ratios," European Financial Management, European Financial Management Association, vol. 9(3), pages 299-314.
    6. Jimenez, Gabriel & Salas, Vicente & Saurina, Jesus, 2006. "Determinants of collateral," Journal of Financial Economics, Elsevier, vol. 81(2), pages 255-281, August.
    7. Menkhoff, Lukas & Neuberger, Doris & Suwanaporn, Chodechai, 2006. "Collateral-based lending in emerging markets: Evidence from Thailand," Journal of Banking & Finance, Elsevier, vol. 30(1), pages 1-21, January.
    8. Juha-Pekka Niinimäki & Tuomas Takalo, 2007. "Benchmarking and Comparing Entrepreneurs with Incomplete Information," Finnish Economic Papers, Finnish Economic Association, vol. 20(2), pages 91-107, Autumn.
    9. Bester, Helmut, 1987. "The role of collateral in credit markets with imperfect information," European Economic Review, Elsevier, vol. 31(4), pages 887-899, June.
    10. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
    11. Lehmann, Erik & Neuberger, Doris, 2001. "Do lending relationships matter?: Evidence from bank survey data in Germany," Journal of Economic Behavior & Organization, Elsevier, vol. 45(4), pages 339-359, August.
    12. Bell, Clive & Clemenz, Gerhard, 2006. "The desire for land: Strategic lending with adverse selection," Journal of Development Economics, Elsevier, vol. 79(1), pages 1-25, February.
    13. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    14. Clive BELL & Gerhard CLEMENZ, 1996. "Credit Markets with Moral Hazard and Heterogenous Valuations of Collateral," Vienna Economics Papers vie9604, University of Vienna, Department of Economics.
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