Optimal debt contracts and moral hazard along the business cycle

Reichlin, Pietro and Siconolfi, Paolo (2002) Optimal debt contracts and moral hazard along the business cycle. [Working Paper]. p. 46.

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We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal “abilities” borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers’ ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations.

Item Type: Report / Paper (Working Paper)
Research documents and activity classification: Working Papers > Refereed Working Papers / of international relevance
Divisions: Department of Business and Management
Additional Information: The definitive version of the paper has been published in "Economic Theory", Vol. 24(1), Pages 75-109, July 2004.
Uncontrolled Keywords: Financial intermediation, business cycle.
MIUR Scientific Area: Area 13 - Economics and Statistics > SECS-P/01 Political Economy
Deposited by: Maria Teresa Nisticò
Date Deposited: 17 Dec 2010 14:42
Last Modified: 21 Apr 2015 23:14
URI: http://eprints.luiss.it/id/eprint/855


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