Bargaining Power and Enforcement in Credit Markets

20 Pages Posted: 14 Dec 2005

See all articles by Garance Genicot

Garance Genicot

Georgetown University - Department of Economics

Debraj Ray

New York University (NYU) - Department of Economics; Autonomous University of Barcelona - Instituto de Analisis Economico (CSIC)

Abstract

In a credit market with enforcement constraints, we study the effects of a change in the outside options of a potential defaulter on the terms of the credit contract, as well as on borrower payoffs. The results crucially depend on the allocation of "bargaining power" between the borrower and the lender.

We prove that there is a crucial threshold of relative weights such that if the borrower has power that exceeds this threshold, her expected utility must go up whenever her outside options come down. But if the borrower has less power than this threshold, her expected payoff must come down with her outside options.

In the former case a deterioration in outside options brought about, say, by better enforcement, must create a Lorenz improvement in state-contingent consumption. In particular, borrower consumption rises in all "bad" states in which loans are taken. In the latter case, in contrast, the borrower's consumption must decline, at least for all the bad states. These disparate findings within a single model permit us to interpret existing literature on credit markets in a unified way.

Keywords: credit market, bargaining power, enforcement, power

JEL Classification: D4, L1, N2, O1

Suggested Citation

Genicot, Garance and Ray, Debraj, Bargaining Power and Enforcement in Credit Markets. Journal of Development Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=869462

Garance Genicot (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-7144 (Phone)
202-687-6102 (Fax)

HOME PAGE: http://www.georgetown.edu/faculty/gg58

Debraj Ray

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10003
United States
212-998-8906 (Phone)
212-995-4186 (Fax)

Autonomous University of Barcelona - Instituto de Analisis Economico (CSIC)

Campus UAB
E-08193 Bellaterra
Spain

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