Competitive Lending with Partial Knowledge of Loan Repayment
We study a competitive credit market in which lenders with partial knowledge of loan repayment use one of three decision criteria - maximization of expected utility, maximin, or minimax regret - to make lending decisions. Lenders allocate endowments between loans and a safe asset, 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. Supposing that a public Authority wants to maximize the net social return to borrowing, we study two interventions in the credit market to achieve this objective. One intervention manipulates the return on the safe asset and the other guarantees a minimum loan return to lenders. In a simple scenario, we find that manipulation of the return on the safe asset can be an effective way to achieve the socially desired outcome if lender beliefs about the return to lending are not too pessimistic relative to the beliefs of the Authority. Contrariwise, guaranteeing a minimum loan return can be effective if lender beliefs are not too optimistic relative to the beliefs of the Authority.
Brock's research was supported in part by National Science Foundation grant SES-0518274 and by the Vilas Trust. Manski's research was supported in part by National Science Foundation grant SES- 0549544. We have benefitted from the opportunity to present this work in a seminar at the Federal Reserve Bank of Chicago, at the June 2008 conference on Bayes Savaged in the Extreme, Norwegian School of Economics and Business Administration, and at the March 2009 conference on Housing, Debt and Financial Market Expectations, Judge Business School, University of Cambridge. We are grateful for comments from Gadi Barlevy. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Competitive Lending with Partial Knowledge of Loan Repayment: Some Positive and Normative Analysis WILLIAM A. BROCK1, CHARLES F. MANSKI2 Article first published online: 21 MAR 2011 DOI: 10.1111/j.1538-4616.2010.00380.x © 2011 The Ohio State University Issue Journal of Money, Credit and Banking Journal of Money, Credit and Banking Volume 43, Issue 2-3, pages 441–459, March-April 2011