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Competitive Lending with Partial Knowledge of Loan Repayment

Author

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  • William A. Brock
  • Charles F. Manski

Abstract

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.

Suggested Citation

  • William A. Brock & Charles F. Manski, 2008. "Competitive Lending with Partial Knowledge of Loan Repayment," NBER Working Papers 14378, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:14378
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    References listed on IDEAS

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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. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
    3. William A. Brock, 2006. "Profiling Problems With Partially Identified Structure," Economic Journal, Royal Economic Society, vol. 116(515), pages 427-440, November.
    4. Charles F. Manski, 2006. "Search Profiling With Partial Knowledge of Deterrence," Economic Journal, Royal Economic Society, vol. 116(515), pages 385-401, November.
    5. Charles F. 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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    Cited by:

    1. Anufriev, Mikhail & Bottazzi, Giulio, 2010. "Market equilibria under procedural rationality," Journal of Mathematical Economics, Elsevier, vol. 46(6), pages 1140-1172, November.
    2. repec:ctc:serie1:def7 is not listed on IDEAS
    3. Tiziana Assenza & William A. Brock & Cars H. Hommes, 2017. "Animal Spirits, Heterogeneous Expectations, And The Amplification And Duration Of Crises," Economic Inquiry, Western Economic Association International, vol. 55(1), pages 542-564, January.

    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts

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