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Credit Mismatch and Breakdown

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This paper studies the phenomenon of mismatch in a decentralized credit market where borrowers and lenders must engage in costly search to establish credit relationships. Our dynamic general equilibrium framework integrates incentive based informational frictions with a matching process highlighted by (i) borrowers’ endogenous market entry and exit decision (entry frictions) and (ii) time and resource costs necessary to locate credit opportunities (search frictions). A key feature of the incentive compatible loan contract negotiated between borrowers and lenders is the interaction of informational frictions (in the form of moral hazard) with entry and search frictions. We find that the removal of entry barriers can eliminate information-based equilibrium credit rationing. More generally, entry and incentive frictions are important in understanding the extent of credit rationing, while entry and search frictions are important for understanding credit market breakdown.

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File URL: http://repec.library.villanova.edu/workingpapers/VSBEcon7.pdf
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Paper provided by Villanova School of Business Department of Economics and Statistics in its series Villanova School of Business Department of Economics and Statistics Working Paper Series with number 7.

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Date of creation: Apr 2009
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Handle: RePEc:vil:papers:7

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Web page: http://www.villanova.edu/business/facultyareas/economics/
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Keywords: Entry; Moral Hazard; Credit Rationing; Credit Mismatch; Credit-Market Breakdown;

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