Working Paper: NBER ID: w14378
Authors: William A. Brock; Charles F. Manski
Abstract: We study a competitive credit market in which lenders with partial knowledge of loan repayment use one of three decision criteria - maximization of expected utility, maximin, or minimax regret - to make lending decisions. Lenders allocate endowments between loans and a safe asset, while borrowers demand loans to undertake investments. Borrowers may incompletely repay their loans when investment productivity turns out to be low ex post. We characterize market equilibrium, the contracted repayment rate being the price variable that equilibrates loan supply and demand. Supposing that a public Authority wants to maximize the net social return to borrowing, we study two interventions in the credit market to achieve this objective. One intervention manipulates the return on the safe asset and the other guarantees a minimum loan return to lenders. In a simple scenario, we find that manipulation of the return on the safe asset can be an effective way to achieve the socially desired outcome if lender beliefs about the return to lending are not too pessimistic relative to the beliefs of the Authority. Contrariwise, guaranteeing a minimum loan return can be effective if lender beliefs are not too optimistic relative to the beliefs of the Authority.
Keywords: credit markets; lending decisions; government intervention; social return; loan repayment
JEL Codes: E43; G11; G18; H81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lender beliefs about loan returns (G21) | lender decision-making (G21) |
| lender decision-making (G21) | equilibrium in the credit market (D53) |
| contracted repayment rate (r) (E43) | allocation of endowments between loans and safe assets (G51) |
| manipulating the return on safe asset (G19) | socially desired outcome (L21) |
| guaranteeing a minimum loan return (G21) | effective intervention if lenders are overly optimistic (G21) |
| government interventions (H53) | lender beliefs (G21) |
| lender beliefs (G21) | market equilibrium (D53) |