Profiting from the Poor in Competitive Credit Markets With Adverse Selection

35 Pages Posted: 8 Jun 2020 Last revised: 20 Jan 2021

See all articles by Dan Bernhardt

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics

Kostas Koufopoulos

University of York

Giulio Trigilia

University of Rochester - Simon Business School

Date Written: May 13, 2020

Abstract

We provide theoretical foundations for positive lender profits in competitive credit markets with asymmetric information, where potential borrowers have scarce collateralizable assets. Strikingly, when some borrowers have negative net present value projects, an equilibrium always exists in which lenders make positive profits, despite their lack of ‘soft’ information and free entry of competitors. We then establish that greater access to collateral for borrowers reduces lender profits, and we relate our findings to the empirical evidence on micro-credit, payday lending, and, more broadly, retail and small business financing.

Keywords: Adverse selection, strictly positive profits, market breakdown

JEL Classification: D82, D86

Suggested Citation

Bernhardt, Dan and Koufopoulos, Kostas and Trigilia, Giulio, Profiting from the Poor in Competitive Credit Markets With Adverse Selection (May 13, 2020). Available at SSRN: https://ssrn.com/abstract=3600046 or http://dx.doi.org/10.2139/ssrn.3600046

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-244-5708 (Phone)

Kostas Koufopoulos

University of York ( email )

Heslington
York, YO1 5DD
United Kingdom

Giulio Trigilia (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

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