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Credit Risk, Credit Rationing, and the Role of Banks: The Case of Risk Averse Lenders

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Abstract

The standard situation of ex post information asymmetry between borrowers and lenders is extended by risk aversion and heterogenous levels of reservation utility of lenders. In a situation of direct contracting optimal incentive compatible contracts are valuable for both, borrowers and lenders. However, there may appear credit rationing as a consequence of borrowers optimal decision making. Introducing a bank into the market increases total wealth due to the appearance of a portfolio effect in the sense of first order stochastic dominance. It can be shown that this effect may even reduce the problem of credit rationing provided it is sufficiently strong.

Suggested Citation

  • Thilo Pausch, 2005. "Credit Risk, Credit Rationing, and the Role of Banks: The Case of Risk Averse Lenders," Discussion Paper Series 271, Universitaet Augsburg, Institute for Economics.
  • Handle: RePEc:aug:augsbe:0271
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    File URL: http://www.wiwi.uni-augsburg.de/vwl/institut/paper/271.pdf
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    References listed on IDEAS

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    1. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    2. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    3. Thilo Pausch & Peter Welzel, 2002. "Credit Risk and the Role of Capital Adequacy Regulation," Discussion Paper Series 224, Universitaet Augsburg, Institute for Economics.
    4. Thilo Pausch, 2003. "The Lender-Borrower Relationship with Risk Averse Lenders," Discussion Paper Series 244, Universitaet Augsburg, Institute for Economics.
    5. Froot, Kenneth A. & Stein, Jeremy C., 1998. "Risk management, capital budgeting, and capital structure policy for financial institutions: an integrated approach," Journal of Financial Economics, Elsevier, vol. 47(1), pages 55-82, January.
    6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    7. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
    8. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-1658, December.
    9. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    10. Greg Kaplan, 2012. "Moving Back Home: Insurance against Labor Market Risk," Journal of Political Economy, University of Chicago Press, vol. 120(3), pages 446-512.
    11. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663.
    12. 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.
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    Keywords

    risk aversion; costly state verification; credit rationing; bank;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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