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Adverse Selection in Credit Markets with Costly Screening

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  • Cheng Wang
  • Stephen D. Williamson

Abstract

#abstract# We develop a credit market model with adverse selection where risk-neutral borrowers self select because lenders make use of a costly screening technology. The model has some features which are similar to the Rothschild-Stiglitz adverse selection model. If an equilibrium exists it is a separating equilibrium, and there exist parameter values for which an equilibrium does not exist. Equilibrium contracts are debt contracts, and this is robust to randomization, in contrast to results for the costly state verification model. This framework can be extended to permit optimal financial intermediary structures, and it potentially has many applications.

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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 9310001.

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Length: 34 pages
Date of creation: 28 Oct 1993
Date of revision: 02 Nov 1993
Handle: RePEc:wpa:wuwpfi:9310001

Note: Zipped using PKZIP v2.04, encoded using UUENCODE v5.15. Zipped file includes 4 files -- AD.093 (body in TeX 34 pages), QQAAGEOJ.STY, GEOPHYSI.STY, and TCILATEX.TEX
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References

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  1. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  2. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  3. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers 583, Queen's University, Department of Economics.
  4. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  5. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  6. Williamson, Stephen D, 1987. "Costly Monitoring, Loan Contracts, and Equilibrium Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 135-45, February.
  7. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  8. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  9. John H. Boyd & Edward C. Prescott & Bruce D. Smith, 1988. "Organizations in Economic Analysis," Canadian Journal of Economics, Canadian Economics Association, vol. 21(3), pages 477-91, August.
  10. 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.
  11. 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.
  12. De Meza, David & Webb, David C., 1988. "Credit market efficiency and tax policy in the presence of screening costs," Journal of Public Economics, Elsevier, vol. 36(1), pages 1-22, June.
  13. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
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Cited by:
  1. Williamson, S.D., 1995. "Discount Window Lending and Deposit Insurance," Working Papers 95-01, University of Iowa, Department of Economics.
  2. Chongwoo Choe, 1995. "Contract Design and Costly Verification Games," Working Papers 1995.18, School of Economics, La Trobe University.

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