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Competitive Lending with Partial Knowledge of Loan Repayment

  • William A. Brock
  • Charles F. Manski

We study a competitive credit market in which lenders with partial knowledge of loan repayment use one of three decision criteria - maximization of expected utility, maximin, or minimax regret - to make lending decisions. Lenders allocate endowments between loans and a safe asset, while borrowers demand loans to undertake investments. Borrowers may incompletely repay their loans when investment productivity turns out to be low ex post. We characterize market equilibrium, the contracted repayment rate being the price variable that equilibrates loan supply and demand. Supposing that a public Authority wants to maximize the net social return to borrowing, we study two interventions in the credit market to achieve this objective. One intervention manipulates the return on the safe asset and the other guarantees a minimum loan return to lenders. In a simple scenario, we find that manipulation of the return on the safe asset can be an effective way to achieve the socially desired outcome if lender beliefs about the return to lending are not too pessimistic relative to the beliefs of the Authority. Contrariwise, guaranteeing a minimum loan return can be effective if lender beliefs are not too optimistic relative to the beliefs of the Authority.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14378.

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Date of creation: Oct 2008
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Publication status: published as Competitive Lending with Partial Knowledge of Loan Repayment: Some Positive and Normative Analysis WILLIAM A. BROCK1, CHARLES F. MANSKI2 Article first published online: 21 MAR 2011 DOI: 10.1111/j.1538-4616.2010.00380.x © 2011 The Ohio State University Issue Journal of Money, Credit and Banking Journal of Money, Credit and Banking Volume 43, Issue 2-3, pages 441–459, March-April 2011
Handle: RePEc:nbr:nberwo:14378
Note: AP ME PE
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  1. David Easley & Maureen O'Hara, 2009. "Ambiguity and Nonparticipation: The Role of Regulation," Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 1817-1843, May.
  2. William A. Brock, 2006. "Profiling Problems With Partially Identified Structure," Economic Journal, Royal Economic Society, vol. 116(515), pages F427-F440, November.
  3. Charles F. Manski, 2006. "Search Profiling With Partial Knowledge of Deterrence," Economic Journal, Royal Economic Society, vol. 116(515), pages F385-F401, November.
  4. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
  5. Charles Manski, 2008. "Adaptive partial policy innovation: coping with ambiguity through diversification," CeMMAP working papers CWP10/08, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
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