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Asymmetric information, option to wait to invest and the optimal level of investment

  • Lensink, Robert
  • Sterken, Elmer

    (Groningen University)

This paper analyzes equilibrium rationing on credit markets in the case of gains from waiting to acquire information about the future profitability of investment. We compare the competitive outcome with the socially optimal level of investment. We show that the opportunity to postpone investment changes the nature of the inefficiencies of the competitive outcome fundamentally. Without the option to wait, high risk firms tend to invest and the outcome is characterized by a situation of underinvestment. If firms can wait high risk firms benefit the most from waiting. In this case low risk firms tend to invest immediately and a situation of overinvestment will result, since from the banks' point of view firms do not delay enough.

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File URL: http://irs.ub.rug.nl/ppn/241132908
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Paper provided by University of Groningen, CCSO Centre for Economic Research in its series CCSO Working Papers with number 199917.

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Date of creation: 1999
Date of revision:
Handle: RePEc:dgr:rugccs:199917
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  1. John H. Boyd & Edward C. Prescott, 1985. "Financial intermediary-coalitions," Staff Report 87, Federal Reserve Bank of Minneapolis.
  2. William G. Gale, 1988. "Economic Effects of Federal Credit Programs," UCLA Economics Working Papers 483, UCLA Department of Economics.
  3. William G. Gale, 1988. "Federal Lending and the Market for Credit," UCLA Economics Working Papers 504, UCLA Department of Economics.
  4. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  5. Williamson, Stephen D, 1988. "Liquidity, Banking, and Bank Failures," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(1), pages 25-43, February.
  6. De Meza, David & Webb, David C., 1988. "Credit market efficiency and tax policy in the presence of screening costs," Journal of Public Economics, Elsevier, vol. 36(1), pages 1-22, June.
  7. Mankiw, N Gregory, 1986. "The Allocation of Credit and Financial Collapse," The Quarterly Journal of Economics, MIT Press, vol. 101(3), pages 455-70, August.
  8. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  9. Ramakrishnan, Ram T S & Thakor, Anjan V, 1984. "Information Reliability and a Theory of Financial Intermediation," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 415-32, July.
  10. Pindyck, Robert S, 1982. "Adjustment Costs, Uncertainty, and the Behavior of the Firm," American Economic Review, American Economic Association, vol. 72(3), pages 415-27, June.
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