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Credit markets under asymmetric information regarding the law

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  • Niinimäki, J-P.

Abstract

This theoretical paper shows that asymmetric information regarding the law generates the same problems as the standard form of asymmetric information: credit rationing, underinvestment, and overinvestment. Collateral or personal guarantees eliminate these problems efficiently under the standard form of asymmetric information, but they are rather inefficient under asymmetric information regarding the law. It is optimal to create a centralized financial intermediary, a bank, which procures legal expertise and evaluates the legal risks on behalf of depositors who lack this legal expertise. The bank provides fundamental asset transformation services to the economy by transforming complex loans (requiring legal expertise) into simple deposits (which do not require legal expertise).

Suggested Citation

  • Niinimäki, J-P., 2019. "Credit markets under asymmetric information regarding the law," The North American Journal of Economics and Finance, Elsevier, vol. 47(C), pages 380-390.
    • Handle: RePEc:eee:ecofin:v:47:y:2019:i:c:p:380-390
    DOI: 10.1016/j.najef.2018.05.003
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