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Risk Rationing and Activity Choice in Moral Hazard Constrained Credit Markets

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  • Stephen Boucher
  • MICHAEL R. CARTER

Abstract

This paper explores the productivity and income distribution e.ects of asymmetric information and risk preferences on the credit market. A model of contract design in the presence of moral hazard is developed in which competitive, risk neutral lenders o.er contracts to risk averse agents who hold the option to invest capital and labor time in an entrepreneurial activity. The model gives rise to the potential for quantity rationing and an additional form of non-price rationing called risk rationing. Both quantity and risk rationed agents would seek credit and carry out the entrepreneurial activity in a first best, or symmetric information world. When information is asymmetric, the menu of available loan contracts shrinks. In equilibrium, neither type of agent ends up with a loan contract, and both undertake a safe, but low return wage labor activity. Quantity rationed agents are involuntarily excluded from the entrepreneurial activity because they are denied any loan contract. Risk rationed agents voluntarily retreat from the credit market and the entrepreneurial activity rather than choose among the limited set of high risk contracts available to them in the presence of asymmetric information. Analysis shows that both quantity and risk rationing are likely to be wealth-biased, inhibiting the activity choice and the income earning potential of low wealth agents, and reproducing initial inequality.
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  • Stephen Boucher & MICHAEL R. CARTER, 2001. "Risk Rationing and Activity Choice in Moral Hazard Constrained Credit Markets," Wisconsin-Madison Agricultural and Applied Economics Staff Papers 445, Wisconsin-Madison Agricultural and Applied Economics Department.
    • Handle: RePEc:wop:wisaes:445
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    References listed on IDEAS

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    Cited by:

    1. Mogues, Tewodaj & Carter, Michael R., 2003. "Social Capital and Incentive Compatibility: Modelling the Accumulation and Use of Social Collateral," Staff Paper Series 460, University of Wisconsin, Agricultural and Applied Economics.
    2. M. Ali Choudhary & Anil K. Jain, 2022. "Credit access and relational contracts: An experiment testing informational and contractual frictions for Pakistani farmers," International Finance Discussion Papers 2022, Board of Governors of the Federal Reserve System (U.S.).
    3. McIntosh, Craig & de Janvry, Alain & Sadoulet, Elisabeth, 2003. "How Rising Competition Among Microfinance Lenders Affects Incumbent Village Banks," CUDARE Working Papers 25073, University of California, Berkeley, Department of Agricultural and Resource Economics.
    4. Mogues, Tewodaj & Carter, Michael R., 2003. "Social Capital And Incentive Compatibility: Modelling The Accumulation And Use Of Social Collateral," Staff Papers 12623, University of Wisconsin-Madison, Department of Agricultural and Applied Economics.

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    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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