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The Equilibrium Allocation of Investment Capital in the Presence of Adverse Selection and Costly State Verification

  • Boyd, J.h.
  • Smith, B.D.

We consider credit rationing in an environment with adverse selection and costly state verification. The presence of costly state verification permits debt contracts to emerge under conditions that we specify. When debt contracts are observed, so is credit rationing. This rationing occurs even if it is possible for rationed borrowers to bid up expected returns to lenders and hence is voluntary. We also show how the adverse selection and costly state verification problems interact and investigate how improvements in information gathering technology impact on the extent of credit rationing.

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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 289.

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Length: 38 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:roc:rocher:289
Contact details of provider: Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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