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Endogenous Leverage and Advantageous Selection in Credit Markets

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  • Plamen T. Nenov

Abstract

I study asset price amplification in an asymmetric information model. Entrepreneurs issue debt to finance investments in a physical asset. They have private information about their success probabilities. For a given debt level, higher asset prices require entrepreneurs to invest more of their own funds. This makes bad entrepreneurs more reluctant to mimic good ones; as a result, good entrepreneurs increase their equilibrium leverage and invest more, and this amplifies the initial asset price increase. This model generates predictions about the credit market that are qualitatively consistent with existing evidence. Received April 24, 2015; editorial decision June 15, 2016 by Editor Itay Goldstein.

Suggested Citation

  • Plamen T. Nenov, 2017. "Endogenous Leverage and Advantageous Selection in Credit Markets," The Review of Financial Studies, Society for Financial Studies, vol. 30(11), pages 3888-3920.
    • Handle: RePEc:oup:rfinst:v:30:y:2017:i:11:p:3888-3920.
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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