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Screening, Bidding, and the Loan Market Tightness

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  • Melanie Cao
  • Shouyong Shi

Abstract

Bank loans are more available and cheaper for new and small businesses in the U.S. in concentrated banking areas than in competitive banking areas. We explain this anomaly by analyzing banks' decisions to screen projects and their competition in loan provisions. It is shown that, by exacerbating the winner's curse, an increase in the number of banks can reduce banks' screening probability by so much that the number of banks that actively compete in loan provisions falls and the expected loan rate rises. This is the case when the screening cost is low, which induces all active bidders to be informed. The opposite outcome occurs when the screening cost is high, in which case there are sufficiently many uninformed banks in bidding to attenuate the winner's curse. We also examine the social optimum. JEL classification: G21, D44, L15

Suggested Citation

  • Melanie Cao & Shouyong Shi, 2001. "Screening, Bidding, and the Loan Market Tightness," Review of Finance, European Finance Association, vol. 5(1-2), pages 21-61.
    • Handle: RePEc:oup:revfin:v:5:y:2001:i:1-2:p:21-61.
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    File URL: http://hdl.handle.net/10.1023/A:1012626030681
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    References listed on IDEAS

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    1. Shi, Shouyong & Cao, Melanie, 1999. "Screening, Bidding, and the Loan Market Tightness," Queen's Economics Department Working Papers 273416, Queen's University - Department of Economics.
    2. von Thadden, Ernst-Ludwig, 2004. "Asymmetric information, bank lending and implicit contracts: the winner's curse," Finance Research Letters, Elsevier, vol. 1(1), pages 11-23, March.
    3. Mitchell A. Petersen & Raghuram G. Rajan, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 110(2), pages 407-443.
    4. Melanie Cao & Shouyong Shi, 2001. "Screening, Bidding, and the Loan Market Tightness," Review of Finance, European Finance Association, vol. 5(1-2), pages 21-61.
    5. Sharpe, Steven A, 1990. "Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships," Journal of Finance, American Finance Association, vol. 45(4), pages 1069-1087, September.
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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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