Peer Group Formation in an Adverse Selection Model

Posted: 20 Sep 2000

See all articles by Beatriz Armendariz

Beatriz Armendariz

University College London - Department of Economics; Harvard University; Harvard University - Department of Economics

Christian Gollier

University of Toulouse 1 - Industrial Economic Institute (IDEI); CESifo (Center for Economic Studies and Ifo Institute)

Abstract

This paper develops an adverse selection model where peer group systems are shown to trigger lower interest rates and remove credit rationing in the case where borrowers are uninformed about their potential partners and ex post state verification (or auditing) by banks is costly. Peer group formation reduces interest rates due to a "collateral effect," namely, cross subsidisation amongst borrowers acts as collateral behind a loan. By uncovering such a collateral effect, this paper shows that peer group systems can be viewed as an effective risk pooling mechanism, and thus enhance efficiency, not just in the full information set up.

JEL Classification: D81, D82, G21

Suggested Citation

Armendariz, Beatriz and Gollier, Christian, Peer Group Formation in an Adverse Selection Model. Economic Journal, Vol. 110, Issue 465, July 2000. Available at SSRN: https://ssrn.com/abstract=236203

Beatriz Armendariz

University College London - Department of Economics ( email )

Gower Street
London WC1E 6BT, WC1E 6BT
United Kingdom

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

Harvard University - Department of Economics

Littauer Center
Cambridge, MA 02138
United States

Christian Gollier (Contact Author)

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

Manufacture des Tabacs
21 Allee de Brienne bat. F
Toulouse Cedex, F-31000
France
+33 61 12 86 30 (Phone)
+33 61 12 86 37 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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