Adverse Selection in Credit Markets: Evidence from a Policy Experiment

Ashok Rai and Stefan Klonner ()
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Ashok Rai: Williams College, http://econ.williams.edu

No 2007-1, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: We test if riskier borrowers are willing to pay higher interest rates than safer borrowers are as predicted by Stiglitz and Weiss (1981). The data are from an Indian financial institution where interest rates are determined by competitive bidding. The government imposed an interest rate ceiling in 1993 and then relaxed the ceiling in 2002. Changes in default patters are analyzed before and after each of these policy changes. We find no evidence of adverse selection despite the use of collateral as a screening device. This study isolates adverse selection from moral hazard and controls for information on riskiness observed by the lender but not by the researcher.

Keywords: Defaults; Risk; Auctions; Asymmetric Information (search for similar items in EconPapers)
JEL-codes: D82 G21 O16 (search for similar items in EconPapers)
Date: 2007-08
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