Competitive Lending with Partial Knowledge of Loan Repayment

32 Pages Posted: 8 Oct 2008 Last revised: 14 Jul 2009

See all articles by William A. Brock

William A. Brock

University of Wisconsin, Madison - Department of Economics; University of Missouri at Columbia - Department of Economics

Charles F. Manski

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: October 2008

Abstract

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.

Suggested Citation

Brock, William A. and Manski, Charles F., Competitive Lending with Partial Knowledge of Loan Repayment (October 2008). NBER Working Paper No. w14378, Available at SSRN: https://ssrn.com/abstract=1278452

William A. Brock

University of Wisconsin, Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
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University of Missouri at Columbia - Department of Economics ( email )

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Columbia, MO 65211
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Charles F. Manski (Contact Author)

Northwestern University - Department of Economics ( email )

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Evanston, IL 60208
United States
847-491-8223 (Phone)
847-491-7001 (Fax)

National Bureau of Economic Research (NBER)

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United States

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