Working Paper: CEPR ID: DP1631
Authors: Pietro Reichlin; Paolo Siconolfi
Abstract: In an economy where entrepreneurs with unequal ?abilities? face alternative investment projects, which differ in their degree of risk and productivity, we analyse the Nash equilibrium contracts arising from a banks-borrowers game in the context of asymmetric information. We show that, for a particular characterization of the game, one can determine the endogenous distribution of projects and the ?type? of contracts (pooling or separating) as functions of the amount of loanable funds. We then apply this game to a general equilibrium aggregative economy with production, populated by overlapping generations of borrowers and lenders. We show that, for a range of parameter values, equilibria are characterized by persistent endogenous cycles.
Keywords: Financial Intermediation; Adverse Selection; Business Cycle
JEL Codes: A10; G14; G20; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Loanable funds (G21) | Proportion of bad projects (H43) |
| Proportion of bad projects (H43) | Business cycle fluctuations (E32) |
| Loanable funds (G21) | Business cycle fluctuations (E32) |
| Critical threshold of loanable funds (E51) | Nature of contracts (from separating to pooling) (L14) |
| Nature of contracts (L14) | Proportion of bad projects (H43) |