Profiting from the Poor in Competitive Credit Markets With Adverse Selection
35 Pages Posted: 8 Jun 2020 Last revised: 20 Jan 2021
Date Written: May 13, 2020
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: Suggested Citation