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Discussion Paper Details

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Title: Adverse Selection, Credit, and Efficiency: the Case of the Missing Market

Author(s): Alberto Mart�n

Publication Date: February 2011

Keyword(s): Adverse Selection, Collateral, Credit Markets, Monitored Lending and Screening

Programme Area(s): Financial Economics

Abstract: We analyze a standard environment of adverse selection in credit markets. In our environment, entrepreneurs who are privately informed about the quality of their projects need to borrow in order to invest. Conventional wisdom says that, in this class of economies, the competitive equilibrium is typically inefficient. We show that this conventional wisdom rests on one implicit assumption: entrepreneurs can only access monitored lending. If a new set of markets is added to provide entrepreneurs with additional funds, efficiency can be attained in equilibrium. An important characteristic of these additional markets is that lending in them must be unmonitored, in the sense that it does not condition total borrowing or investment by entrepreneurs. This makes it possible to attain efficiency by pooling all entrepreneurs in the new markets while separating them in the markets for monitored loans.

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Bibliographic Reference

Mart�n, A. 2011. 'Adverse Selection, Credit, and Efficiency: the Case of the Missing Market'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=8226