Research Discussion Papers, Bank of Finland
No 14/2004:
Asymmetric information in credit markets and entrepreneurial risk taking
Timo Vesala
Abstract: The paper constructs a search-theoretic model of credit
markets with a bilateral trading mechanism that enables the manageable
introduction of asymmetric information. Borrowers´ success probabilities
are unobservable to financiers, but the degree of risk in observable
projects can be used as a sorting device. We find that the efficiency of a
perfect Bayesian equilibrium depends negatively/positively on the credit
market ´tightness´/liquidity. In general equilibrium, where the underlying
market conditions are endogenously determined, steady states with greater
credit market tightness are always associated with increasingly excessive
investment in risky projects. Since tighter market conditions also imply
less intense competition among financiers, the commonly asserted trade-off
between competition and efficiency does not emerge. Tighter monetary policy
is shown to worsen the adverse effect of informational frictions on
efficiency.
Keywords: credit market; asymmetric information; search; risk taking; (follow links to similar papers)
JEL-Codes: D82; D83; G14; G21; G24; (follow links to similar papers)
35 pages, July 14, 2004
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