Dynamic Adverse Selection and Belief Update in Credit Markets

Kee-Youn Kang and Inkee Jang

MPRA Paper from University Library of Munich, Germany

Abstract: We develop a dynamic model of debt contracts with adverse selection and belief updates. In the model, entrepreneurs borrow investment goods from lenders to run businesses whose returns depend on entrepreneurial productivity and common productivity. The entrepreneurial productivity is the entrepreneur's private information, and the lender constructs beliefs about the entrepreneur's productivity based on the entrepreneur's business operation history, common productivity history, and terms of the contract. The model provides insights on the dynamic and cross-sectional relation between firm age and credit risk, cyclical asymmetry of the business cycle, slow recovery after a crisis, and the constructive economic downturn.

Keywords: Adverse selection; Bayesian learning; Debt contracts; Belief update (search for similar items in EconPapers)
JEL-codes: C78 D82 E44 G0 (search for similar items in EconPapers)
Date: 2020-02-01
New Economics Papers: this item is included in nep-bec, nep-cta, nep-ent, nep-mac and nep-mic
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:99071

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