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Adverse Selection and Search Frictions in Corporate Loan Contracts

Author

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  • Beyhaghi, Mehdi

    (College of Business, University of Texas at San Antonio)

  • Mahmoudi, Babak

    (School of Humanities and Social Sciences, Nazarbayev University)

  • Mohammadi, Ali

    (CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology)

Abstract

We provide empirical evidence of both (1) price dispersion and (2) credit rationing in the corporate loan market. We argue that these properties are caused by two factors: an adverse selection resulting from the information asymmetry between lenders and borrowers, and search frictions in matching borrowers with lenders. We develop a model of loan markets in which lenders post an array of heterogeneous contracts, then borrowers tradeoff terms of loan contracts and matching probability between themselves. We show that a unique separating equilibrium exists where each type of borrower applies to a certain type of contract.

Suggested Citation

  • Beyhaghi, Mehdi & Mahmoudi, Babak & Mohammadi, Ali, 2014. "Adverse Selection and Search Frictions in Corporate Loan Contracts," Working Paper Series in Economics and Institutions of Innovation 350, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
    • Handle: RePEc:hhs:cesisp:0350
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    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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