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Welfare-Improving Adverse Selection in Credit Markets

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  • James Vercammen

    (University of British Columbia, Canada)

Abstract

A model of simultaneous adverse selection and moral hazard in a competitive credit market is developed and used to show that aggregate borrower welfare may be higher in the combined case than in the moral-hazard-only case. Adverse selection can be welfare improving because in the pooling equilibrium of the combined model, high-quality borrowers cross subsidize low-quality borrowers. The cross subsidization reduces the overall moral hazard effort effects, and the resulting gain in welfare may more than offset the welfare loss stemming from distorted investment choices. The analysis focuses on pooling equilibria because model structure precludes separating equilibria. Copyright 2002 by the Economics Department of the University of Pennsylvania and Osaka University Institute of Social and Economic Research Association

Suggested Citation

  • James Vercammen, 2002. "Welfare-Improving Adverse Selection in Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(4), pages 1017-1033, November.
    • Handle: RePEc:ier:iecrev:v:43:y:2002:i:4:p:1017-1033
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    Cited by:

    1. Margherita Bottero & Giancarlo Spagnolo, 2013. "Limited credit records and market outcomes," Temi di discussione (Economic working papers) 903, Bank of Italy, Economic Research and International Relations Area.
    2. Gottlieb, Daniel & Maestri, Lucas Jóver, 2004. "Banning information as a redistributive device," FGV EPGE Economics Working Papers (Ensaios Economicos da EPGE) 555, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil).
    3. Elena Del Rey & Bertrand Verheyden, 2008. "Loans, Insurance and Failures in the Credit Market for Students," Working Papers 359, Barcelona School of Economics.
    4. Sandrine Ollier, 2006. "Un effet pervers de la responsabilité limitée," Recherches économiques de Louvain, De Boeck Université, vol. 72(3), pages 265-286.

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