Credit markets with asymmetric information (Q1078051)

The concepts of the (rather) new field of ''information economics'' are applied to the analysis of credit markets. The favourite ''gimmicks'' of the economics of (asymmetric) information, ''adverse selection'' and ''moral hazard'' are used to explain the possibility of equilibrium credit rationing. The author presents four reasons for a possible adverse influence of interest rate increases on the probability of default of borrowers. One of them is the ''Honesty-model''. Here, borrowers differ with respect to the costs of default and a larger proportion refuses to repay the loan as the interest rate is increased. This and other reasons make banks hesitate to increase the loan rate beyond a bank optimal rate, even if there is an excess demand at that rate. Most interestingly, the explanations for credit rationing are presented in a multiperiod framework. In the case of the Honesty-model, the multiperiod analysis allows for the endogenisation of the costs of default. In the three other models, the multiperiod analysis turns out to be especially fruitful, too. It is also shown that screening of customers will not outrule the possibility of rationing equilibria, in general. The book is well written and represents an important contribution to the theory of financial markets.