Insider Rates vs. Outsider Rates in Lending

24 Pages Posted: 28 Mar 2011

See all articles by Lamont Black

Lamont Black

DePaul University - Driehaus College of Business; Center for Financial Services

Date Written: July 1, 2008

Abstract

The presence of private information about a firm can affect the competition among potential lenders. In the Sharpe (1990) model of information asymmetry among lenders (with the von Thadden (2004) correction), an uninformed outside bank faces a winner’s curse when competing with an informed inside bank. This paper examines the model’s prediction for observed interest rates at an inside vs. outside bank. Although the outside bank wins more bad firms than the inside bank, the winner’s curse also causes the outside rate conditional on firm type to be lower in expectation than the inside rate conditional on firm type. I show analytically that the expected interest rate at the outsider can be either higher or lower than the expected interest rate at the insider, depending on the net of these two effects. Under the assumption that the banks split the firms in a tie bid, a numerical solution shows that the outside expected interest rate is higher than the inside expected interest rate for high quality borrower pools, but the outside expected interest rate is lower for low quality borrower pools.

Keywords: Banking Relationships, Competition Under Asymmetric Information, Informational Lock-In, Auctions

JEL Classification: G21, C72, D44, D82

Suggested Citation

Black, Lamont, Insider Rates vs. Outsider Rates in Lending (July 1, 2008). FEDS Working Paper No. 2008-36, Available at SSRN: https://ssrn.com/abstract=1793373

Lamont Black (Contact Author)

DePaul University - Driehaus College of Business ( email )

1 East Jackson Blvd.
Chicago, IL 60604-2287
United States
312-362-5617 (Phone)
312-362-6566 (Fax)

HOME PAGE: http://driehaus.depaul.edu/faculty-and-staff/faculty/Pages/black-lamont.aspx

Center for Financial Services

1 East Jackson Blvd.
Chicago, IL 60604-2287
United States

HOME PAGE: http://https://business.depaul.edu/about/centers-institutes/financial-services/Pages/default.aspx

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
45
Abstract Views
602
PlumX Metrics