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A re-examination of credit rationing in the Stiglitz and Weiss model

Su, Xunhua
Working paper
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URI
http://hdl.handle.net/11250/163995
Date
2010-11
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  • Discussion papers (FOR) [514]
Abstract
To explain the widely observed phenomenon of credit rationing, Stiglitz and Weiss

(1981) propose a theory of random rationing under imperfect information. With a

simple model plausibly expanding the Stiglitz and Weiss setting, we argue that, random

rationing occurs only in some extreme cases and hence is not likely to be a prevalent

phenomenon. We start by illustrating that the Stiglitz and Weiss (1981) model and

hence random rationing are quite sensitive to the assumption of the ranking of projects.

Given that the ranking is according to the Mean-preserving Spread, there is adverse

selection but no moral hazard. In the absence of moral hazard, random rationing is

almost impossible to occur. Then by presuming the coexistence of adverse selection

and moral hazard, we derive two required conditions for the occurrence of random

rationing. First, random rationing occurs only if collateral has an overall deadweight

cost other than the negative adverse selection effect. As collateral is a widely observed

debt feature in practice, such an overall deadweight cost should not be the case for

the majority of borrowers. Second, the occurrence of random rationing entails that

the potential negative effects of the loan rate, collateral, loan size and any restrictive debt covenant simultaneously overweigh their positive effects exactly at the current

contracting level. In this case, the zero-profit curve of the lender degenerates to a

single point and borrowers face a take-it-or-leave-it offer. We conjecture that such a

required condition leaves little space for the significance of random rationing.
Publisher
Norwegian School of Economics and Business Administration. Department of Finance and Management Science
Series
Discussion paper
2010:14

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