Multiple borrowing and adverse selection in credit markets

An entrepreneur planning a risky expansion of his small business project may prefer to fund the expansion by soliciting several loans from different lenders. While this is inefficient due to the duplication of screening and monitoring costs, it works to the entrepreneur’s advantage if he can lower h...

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Bibliographic Details
Published in:Oxford economic papers 2018-01, Vol.70 (1), p.286-299
Main Author: Van Tassel, Eric
Format: Article
Language:English
Subjects:
Adverse selection
Bond markets
Borrowing
Credit
Entrepreneurs
Interest rates
Loans
Small business
Soliciting
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Summary:An entrepreneur planning a risky expansion of his small business project may prefer to fund the expansion by soliciting several loans from different lenders. While this is inefficient due to the duplication of screening and monitoring costs, it works to the entrepreneur’s advantage if he can lower his risk premium. When entrepreneurs are able to take out multiple loans in equilibrium, it takes place within a pooling contract, characterized by cross-subsidization. This kind of borrowing in the credit market leads to high interest rates and, in some cases, market failure due to adverse selection.
ISSN:0030-7653
1464-3812
DOI:10.1093/oep/gpx038