Loan guarantees and SMEs' investments under asymmetric information and Bayesian learning ✩

49 Pages Posted: 7 Sep 2019 Last revised: 5 May 2024

See all articles by Pengfei Luo

Pengfei Luo

Hunan University - School of Finance and Statistics

Huamao Wang

University of Nottingham; Nottingham University Business School

Zhaojun Yang

Southern University of Science and Technology - Department of Finance

Date Written: May 5, 2024

Abstract

We develop a dynamic investment model with loan guarantees wherein insurers face information disadvantages and learn about borrower quality. Borrowers signal their qualities through investment timing, which is characterized by the investment threshold and elapsed time. We derive the conditions for separating or pooling equilibria. We show that the separating investment threshold is constant and determined mainly by the maximum threshold preventing mimicry. If project risk is higher (lower) than the market growth rate, the pooling investment threshold declines (increases) with elapsed time, and learning enhances (reduces) the willingness of high-quality borrowers to wait. Learning alleviates adverse selection and reduces guarantee costs. These effects are more pronounced with a greater uncertainty of the insurer on borrower quality. We reveal dual effects of waiting. The worse the market prospect, the higher the value of waiting in pooling outcomes. Fee-for-guarantee swaps are superior to equity-for-guarantee swaps in environments with marked information asymmetry.

Keywords: Asymmetric information, loan guarantees, real investment, Bayesian learning, signaling game

JEL Classification: H81, D82, D83

Suggested Citation

Luo, Pengfei and Wang, Huamao and Yang, Zhaojun, Loan guarantees and SMEs' investments under asymmetric information and Bayesian learning ✩ (May 5, 2024). Available at SSRN: https://ssrn.com/abstract=3445784 or http://dx.doi.org/10.2139/ssrn.3445784

Pengfei Luo

Hunan University - School of Finance and Statistics ( email )

Shijiachong Road 109#
Changsha, Hunan 410079
China

Huamao Wang

University of Nottingham ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

Nottingham University Business School ( email )

Zhaojun Yang (Contact Author)

Southern University of Science and Technology - Department of Finance ( email )

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