Collateral and Competitive Equilibria with Moral Hazard and Private Information

Authors

  • YUK-SHEE CHAN,

  • ANJAN V. THAKOR

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    • Chan is a Visiting Associate Professor of Finance and Business Economics, School of Business, University of Southern California, and an Associate Professor of Finance, J. L. Kellogg Graduate School of Management, Northwestern University. Thakor is an Associate Professor of Finance, School of Business, Indiana University. We thank an anonymous referee and an associate editor for very useful comments. We have also benefited from the comments of seminar participants at University of Southern California, Indiana University, University of Pennsylvania, and University of California, Berkeley. All remaining errors are our own.


ABSTRACT

The authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications. Both moral hazard and adverse selection are considered. The principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts. Specifically, some well-known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept. Two somewhat surprising results emerge. First, high-quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits. Second, high-quality borrowers may put up more collateral.

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