Models of optimal contract in lending: Evaluating the impact of diversified versus focused policies on riskiness of borrower base

Fathali Firoozi and Donald Lien

The North American Journal of Economics and Finance, 2022, vol. 63, issue C

Abstract: Empirical studies on bank lending policies have offered contradictory results regarding the impact of each of the two distinct lending policies of focused and diversification on riskiness of lender’s borrower base. This study first constructs a general model of contracts for lending under asymmetric information and characterizes the equilibrium outcomes under each of the two lending policies. It then demonstrates that the relative preferences of borrower groups towards bank loan plays a key role in determining if a lending policy switch between the two policies increases or decreases the riskiness of the bank’s borrower base. The results offer a rational explanation for the existing contradictory results in the empirical literature.

Keywords: Asymmetric information; Borrower risk; Likelihood ratio measure of risk (search for similar items in EconPapers)
JEL-codes: C7 D8 G2 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:63:y:2022:i:c:s1062940822001450

DOI: 10.1016/j.najef.2022.101810

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