Collateral and Credit Supply

Joseph Atta-Mensah ()

Working Papers from Bank of Canada

Abstract: The author examines the role of collateral in an environment where lenders and borrowers possess identical information and similar beliefs about its future value. Using option-pricing techniques, he shows that a secured loan contract is equivalent to a regular bond and an embedded option to the borrower to default. He finds that the lender will not advance to the borrower a loan that exceeds the market value of the collateral, and that the supply of loans increases with a rise in the market value of the collateral. Increases in the volatility of the value of the collateral, interest rate, and dividend rate of the collateral independently depress the loan supply. The author also derives the cost of a third-party guarantee of a loan and an implied risk premium.

Keywords: Credit and credit aggregates; Economic models (search for similar items in EconPapers)
JEL-codes: E51 E53 G11 G12 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-mfd and nep-rmg
Date: 2003
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