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Collateral, heterogeneity in risk attitude and the credit market equilibrium

  • Coco, Giuseppe

This paper examines the argument that the availability of collateral rules out credit rationing. A model of the credit market with ex-ante asymmetric information and heterogeneous entrepreneurs' attitudes towards risk is set up. It is shown that, due to the interplay between project choice and entrepreneurs' preferences, using collateral as a signal to screen safer projects may prove impossible. Instead, a partially-separating two-contracts equilibrium with rationing at one contract emerges. Contrary to previous theoretical research and consistently with conventional wisdom and systematic evidence, the use of collateral is never negatively correlated with project risk.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 43 (1999)
Issue (Month): 3 (March)
Pages: 559-574

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Handle: RePEc:eee:eecrev:v:43:y:1999:i:3:p:559-574
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  1. David Besanko & Anjan V. Thakor, 2004. "Competitive Equilibrium in the Credit Market under Asymmetric Information," Finance 0411045, EconWPA.
  2. Bester, Helmut, 1987. "The role of collateral in credit markets with imperfect information," European Economic Review, Elsevier, vol. 31(4), pages 887-899, June.
  3. 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.
  4. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
  5. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September.
  6. Coco, Guiseppe, 1997. "Collateral, Heterogeneity in Risk Attitude and the Credit Market Equilibrium," Discussion Papers 9702, Exeter University, Department of Economics.
  7. Chan, Yuk-Shee & Kanatas, George, 1985. "Asymmetric Valuations and the Role of Collateral in Loan Agreements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(1), pages 84-95, February.
  8. Leeth, John D. & Scott, Jonathan A., 1989. "The Incidence of Secured Debt: Evidence from the Small Business Community," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 379-394, September.
  9. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
  10. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October.
  11. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January.
  12. de Meza, David & Southey, Clive, 1996. "The Borrower's Curse: Optimism, Finance and Entrepreneurship," Economic Journal, Royal Economic Society, vol. 106(435), pages 375-86, March.
  13. Stiglitz, Joseph E & Weiss, Andrew, 1992. "Asymmetric Information in Credit Markets and Its Implications for Macro-economics," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 694-724, October.
  14. Boot, Arnoud W A & Thakor, Anjan V & Udell, Gregory F, 1991. "Secured Lending and Default Risk: Equilibrium Analysis, Policy Implications and Empirical Results," Economic Journal, Royal Economic Society, vol. 101(406), pages 458-72, May.
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