Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2010/14: A Re-examination of Credit Rationing in the Stiglitz and Weiss Model

Xunhua Su ()
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Xunhua Su: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: With a more general setting, we illustrate that credit rationing in the Stiglitz and Weiss (1981) model is sensitive to the ranking of projects. Given that the ranking is according to the mean-preserving-spread, adverse selection and moral hazard cannot co-exist and credit rationing occurs only under extreme conditions. Even if a more general ranking according to the second-order-stochastic-dominance allows for the coexistence of adverse selection and moral hazard, credit rationing implies a take-it-or-leave-it choice for both contract parties and requires that borrowers' collateral amounts are positively correlated with their risk. We argue that these required conditions leave little room for the signicance of credit rationing.

Keywords: Credit rationing; credit market; Stiglitz and Weiss; collateral

JEL-codes: D82; G21; G30

22 pages, First version: November 5, 2010. Revised: December 31, 2010.

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