class 26 Tourist Trap Model post

class 26 Tourist Trap Model post - Class 26 Tourist Trap...

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Class 26 Tourist Trap and Final Student Founders “is trying to connect Michigan's entrepreneurial community”: St d tF d www.StudentFounders.com
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Last Time rading Shares of a Company ± Trading Shares of a Company ± Moral Hazard: ± How to pay a CEO ± Who should hold Mortgages?
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Today oral Hazard: ± Moral Hazard: ± How to pay a CEO ± ho should hold Mortgages? Who should hold Mortgages? ± Tourist Trap and Search: Models of Decentralized arkets Markets ± Final Exam Information
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Mortgages: Allocation of Risk and Incentives Mortgages odel Mortgages are often distributed by small local banks. ocal anks re ave mall ortfolio, Model Local bank can screen applicants carefully or not, e=1 or e=0. Î Local banks are have small portfolio, conservative asset management, and are less diversified. Mortgages are then sold further to mutual If applicant is good: Profit 36 bad: Profit 0 e=0 : probability of bad applicant is 2/3 funds and international banks, like UBS (better diversified, higher risk tolerance). Moral Hazard Problem: e=1 : probability of bad applicant is 1/3 . Bank’s payoff function over w and effort: If mortgages are hold by international holder, local bank has: Less screening incentives u(w, e) = w 0.5 -e Less monitoring incentives Î Trade Off: Local Bank must keep some efault sk rovide centives r creening default risk to provide incentives for screening and monitoring.
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Mortgages odel Will Bank exert effort? No Effort: EU =0.33(36) 0.5 + 0.66(0) = Model Local bank can screen applicants carefully or not, e=1 or e=0. 2 Effort: EU =0.66(36 0.5 –1)+0.33 ( 0 – 1) = 3 If applicant is good: Profit 36 bad: Profit 0 e=0 : probability of bad applicant is 2/3 Observable: If Fund buys off mortgages ank U ( 6 e=1 : probability of bad applicant is 1/3 . Bank’s payoff function over w and effort: Bank EU = (16 ) 0.5 –1 = 3 Fund: E Π = 0.66(36)±–16 u(w, e) = w 0.5 -e oT” Suppose Fund could buy mortgages ( ) = 24 – 16 = 8 WoT : Suppose Fund could buy mortgages and observe payoff. Fund would pay w=16 and require effort careful screening of applicants). Indifference: (g p p ) We assume that bank accepts if indifferent. Why?
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class 26 Tourist Trap Model post - Class 26 Tourist Trap...

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