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Bank Monitoring Incentives Under Moral Hazard and Adverse Selection

Author

Listed:
  • Nicolás Hernández Santibáñez

    (University of Michigan)

  • Dylan Possamaï

    (Columbia University)

  • Chao Zhou

    (National University of Singapore)

Abstract

In this paper, we extend the optimal securitisation model of Pagès and Possamaï between an investor and a bank to a setting allowing both moral hazard and adverse selection. Following the recent approach to these problems of Cvitanić, Wan and Yang, we characterise explicitly and rigorously the so-called credible set of the continuation and temptation values of the bank, and obtain the value function of the investor as well as the optimal contracts through a recursive system of first-order variational inequalities with gradient constraints. We provide a detailed discussion of the properties of the optimal menu of contracts.

Suggested Citation

  • Nicolás Hernández Santibáñez & Dylan Possamaï & Chao Zhou, 2020. "Bank Monitoring Incentives Under Moral Hazard and Adverse Selection," Journal of Optimization Theory and Applications, Springer, vol. 184(3), pages 988-1035, March.
    • Handle: RePEc:spr:joptap:v:184:y:2020:i:3:d:10.1007_s10957-019-01621-9
    DOI: 10.1007/s10957-019-01621-9
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    Cited by:

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    2. Daniel E. Rigobon & Ronnie Sircar, 2022. "Formation of Optimal Interbank Lending Networks under Liquidity Shocks," Papers 2211.12404, arXiv.org.
    3. Daniel Krv{s}ek & Dylan Possamai, 2023. "Randomisation with moral hazard: a path to existence of optimal contracts," Papers 2311.13278, arXiv.org.
    4. Sarah Bensalem & Nicolás Hernández Santibáñez & Nabil Kazi-Tani, 2022. "A Continuous-Time Model of Self-Protection," Working Papers hal-02974961, HAL.

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