11.12 - Credit Rationing in Markets with Imperfect...

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Credit Rationing in Markets with Imperfect Information by Stiglitz and Weiss
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Stiglitz and Weiss Òscar Jordà U.C. Davis 2 Idea : show that in a competitive equilibrium a loan market may be characterized by credit rationing . Mechanism: the interest rate a bank charges may itself affect the riskiness of a pool of loans by either: 1. sorting potential borrowers – adverse selection 2. affecting the actions of borrowers – moral hazard Information asymmetry: borrowers have different probability of repayment but banks can’t identify “good” borrowers from “bad.” Hence prices act as a screening device.
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Stiglitz and Weiss Òscar Jordà U.C. Davis 3 Incentives: higher prices cause borrowers to select riskier projects. Expected returns * ˆ r bank optimal rate
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Stiglitz and Weiss Òscar Jordà U.C. Davis 4 The price mechanism may not clear the loan market if interest rates go above * ˆ r since the bank would be attracting worse risk. Hence the bank’s best strategy is to ration credit whenever demand pushes interest rates above * ˆ r . Credit Rationing – Definitions: 1. given loan applicants that appear equal, some receive a loan and some do not even when they offer to pay a higher interest rate. 2. some individuals unable to get a loan under one supply schedule at any interest rate would get a loan under a larger schedule.
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Stiglitz and Weiss Òscar Jordà U.C. Davis 5 Interest Rates as screening devices ± Let θ index projects
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11.12 - Credit Rationing in Markets with Imperfect...

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