Advanced Search
MyIDEAS: Login

The Loan Contract with Costly State Verification and Subjective Beliefs

Contents:

Author Info

  • Carsten Krabbe Nielsen

    ()
    (Istituto Politica Economica, Universita Cattolica and Korea University)

Abstract

We generalize the characterization of the loan contract due to Gale and Hellwig (1985) to the case of risk aversion of the borrower and diverse subjective beliefs about the outcome of the investment. We continue to assume costly state verification (Townsend, 1979) i.e. that the lender must incur costs in order to observe the outcome of the project. Contract terms now reflect returns on capital as well as risk sharing and trade on the differences in probabilities. Because there are no financial markets where agents could purchase insurance for state contingencies, private contracting replaces markets for contingent claims. This also means that verification states are not necessarily interpreted as "default" states. We characterize the optimal contract showing that (i) the contractual payoff in verification states varies by states in accord with risk aversion and probability belief of the two parties, and (ii) the verification region may consist of several intervals. We provide conditions and examples to show that when the borrower is more optimistic than the bank, there may be fewer verification regions.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://econ.korea.ac.kr/~ri/WorkingPapers/w0918.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Institute of Economic Research, Korea University in its series Discussion Paper Series with number 0918.

as in new window
Length: 26 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:iek:wpaper:0918

Contact details of provider:
Postal: 1-5-Ga, Anam-dong, Sung buk-ku, Seoul, 136-701
Phone: (82-2)3290-1633
Fax: (82-2) 928-4948
Web page: http://econ.korea.ac.kr/~ri
More information through EDIRC

Related research

Keywords: Loan Contract; Costly State Verification; Subjective Beliefs;

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
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.:
as in new window
  1. Frankel, Jeff & Froot, Ken, 1986. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," Department of Economics, Working Paper Series qt1972q8wm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  2. Khalil, Fahad & Parigi, Bruno M, 1998. "Loan Size as a Commitment Device," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 135-50, February.
  3. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  4. Guillaume Carlier & Ludovic Renou, 2005. "A costly state verification model with diversity of opinions," Economic Theory, Springer, vol. 25(2), pages 497-504, 02.
  5. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
  6. Gaia Garino & Peter Simmons, 2006. "Costly State Verification with Varying Risk Preferences and Liability," Journal of Economic Surveys, Wiley Blackwell, vol. 20(1), pages 71-110, 02.
  7. Jeffrey A. Frankel & Kenneth A. Froot, 1985. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers 1672, National Bureau of Economic Research, Inc.
  8. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  9. Shinji Takagi, 1991. "Exchange Rate Expectations: A Survey of Survey Studies," IMF Staff Papers, Palgrave Macmillan, vol. 38(1), pages 156-183, March.
  10. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:iek:wpaper:0918. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kim, Jisoo).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.