We study a competitive credit market in which lenders, having partial knowledge of loan repayment, use a Bayesian, maximin, or minimax-regret criterion to make lending decisions. Lenders allocate endowments between loans and a safe investment, while borrowers demand loans to undertake investments. Borrowers may incompletely repay their loans when investment productivity turns out to be low ex post. We characterize market equilibrium, the contracted repayment rate being the price variable that equilibrates loan supply and demand. We explore market dynamics when a credit market that is initially in steady state experiences an unanticipated shock that temporarily lowers the productivity of borrower investments. The shock reduces loan repayment and lenders, not knowing whether the shock is temporary, then reduce loan supply. We study two forms of government intervention to restore the steady state. One policy manipulates the return on the safe investment and the other guarantee a minimum loan return to lenders. We conclude that the minimum-return guarantee is preferable. This policy directly reduces lender ambiguity in a transparent manner.
Charles F. Manski, Professor of Economics, Northwestern University William A. Brock, Professor of Economics, University of Wisconsin
Click on
the working paper title at the top of this
page to download a free pdf of the paper.*
If You Need to Order a Hard Copy: Hard copies
of IPR working papers cost $5.00 each (international orders are $10 each). We only accept checks drawn on U.S. bank and payable in U.S. funds. Checks or money orders should be made
payable to Northwestern University and sent to the following address:
Publications Department - WP Orders
Institute for Policy Research
2040 Sheridan Rd., Evanston, IL 60208-4100.
For information, call 847-491-8712 or email ipr@northwestern.edu.
Please note that we do not accept credit cards.
*Adobe Acrobat Reader 5.0 (or higher) is needed to read the Acrobat pdf.
If you need to install Acrobat Reader, click the button below. Once the file
has downloaded onto your desktop, run it to install the reader on your hard
drive.
