'Long Term Debt with Hidden Borrowing'

41 Pages Posted: 13 Oct 2008

See all articles by Heski Bar-Isaac

Heski Bar-Isaac

University of Toronto - Rotman School of Management

Vicente Cuñat

London School of Economics & Political Science (LSE) - Financial Markets Group

Date Written: January 2008

Abstract

We consider borrowers with the opportunity to raise funds from a competitive banking sector that shares information, and from an alternative hidden lender. The presence of the hidden lender allows borrowers to conceal poor results from their banks and, thus, restricts the contracts that can be obtained from the banking sector and reduces welfare. In equilibrium, some borrowers obtain funds from both the banking sector and the inefficient hidden lender simultaneously; cross-subsidies arise between different borrowers and this leads to too little liquidation. Imposing distributionalassumptions, we fully characterize outcomes and show that as the cost of borrowingfrom the hidden lender increases, total welfare increases. We generalize the model toallow for a partially hidden lender and obtain qualitatively similar results.

Keywords: Long-term debt, hidden borrowing, debt contracts, adverse selection

Suggested Citation

Bar-Isaac, Heski and Cuñat, Vicente, 'Long Term Debt with Hidden Borrowing' (January 2008). NYU Working Paper No. EC-05-04. Available at SSRN: https://ssrn.com/abstract=1282529

Heski Bar-Isaac (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416 978 3626 (Phone)

HOME PAGE: http://https://sites.google.com/site/heskibarisaac/home

Vicente Cuñat

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

HOME PAGE: http://www.vicentecunat.com

Register to save articles to
your library

Register

Paper statistics

Downloads
39
Abstract Views
339
PlumX Metrics