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Moral Hazard and Collateral as Screening Device: Empirical and Experimental Evidence

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  • C. Monica Capra
  • Matilde Fernandez
  • Irene Ramirez-Comeig

Abstract

This paper tests the separating role of contracts that involve both interest rates and collateral in credit markets with asymmetric information. To test this prediction data from real credit markets and controlled experiments are used. Using a sample of credits to small and medium-sized firms in Valencia, Spain, we relate two different types of contracts with an objective approximation to each ex ante borrower risk, i. e., the real outcome of each loan and other relevant variables. Moreover, two incentive compatible contracts are designed and decisions analyzed under two different experimental treatments, one with moral hazard. Results confirm that borrowers of lower risk choose contracts with higher collateral and a lower interest rate. However, it is ascertained that moral hazard reduces separation.

Suggested Citation

  • C. Monica Capra & Matilde Fernandez & Irene Ramirez-Comeig, 2005. "Moral Hazard and Collateral as Screening Device: Empirical and Experimental Evidence," Emory Economics 0505, Department of Economics, Emory University (Atlanta).
  • Handle: RePEc:emo:wp2003:0505
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    References listed on IDEAS

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    1. Stiglitz, Joseph E & Weiss, Andrew, 1992. "Asymmetric Information in Credit Markets and Its Implications for Macro-economics," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 694-724, October.
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    6. Machauer, Achim & Weber, Martin, 1998. "Bank behavior based on internal credit ratings of borrowers," Journal of Banking & Finance, Elsevier, vol. 22(10-11), pages 1355-1383, October.
    7. Coco, Giuseppe, 1999. "Collateral, heterogeneity in risk attitude and the credit market equilibrium," European Economic Review, Elsevier, vol. 43(3), pages 559-574, March.
    8. Boot, Arnoud W A & Thakor, Anjan V & Udell, Gregory F, 1991. "Secured Lending and Default Risk: Equilibrium Analysis, Policy Implications and Empirical Results," Economic Journal, Royal Economic Society, vol. 101(406), pages 458-472, May.
    9. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
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    11. Chan, Yuk-Shee & Kanatas, George, 1985. "Asymmetric Valuations and the Role of Collateral in Loan Agreements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(1), pages 84-95, February.
    12. Grinblatt, Mark & Hwang, Chuan Yang, 1989. " Signalling and the Pricing of New Issues," Journal of Finance, American Finance Association, vol. 44(2), pages 393-420, June.
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