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The adverse selection problem in imperfectly competitive credit markets

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  • Mälkönen, Ville
  • Vesala, Timo

Abstract

We study the adverse selection problem in imperfectly competitive credit markets and illustrate the circumstances where a separating equilibrium emerges, even without collateral.The borrowers are heterogeneous in their preferences concerning the banks.Separation obtains in market segments where the 'high risk' borrowers receive credit from their preferred bank.The 'low risk' borrowers choose the ex-ante less-preferred bank that offers loan contracts with lower interest rates.The availability of credit will be maximized under an intermediate level of competition, a prediction that is supported by recent empirical evidence.

Suggested Citation

  • Mälkönen, Ville & Vesala, Timo, 2006. "The adverse selection problem in imperfectly competitive credit markets," Bank of Finland Research Discussion Papers 26/2006, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2006_026
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    More about this item

    Keywords

    asymmetric information; credit rationing; bank differentiation;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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