Leverage dynamics and credit quality

Guillermo Ordonez, David Perez-Reyna and Motohiro Yogo

Journal of Economic Theory, 2019, vol. 183, issue C, 183-212

Abstract: We study a dynamic model of collateralized credit markets with asymmetric information, which allows for a rich set of signaling strategies based on the path of debt and repayment. Whether credit history reveals private information about credit quality depends on the degree of uncertainty in collateral value. When uncertainty is low, good borrowers fully and costlessly separate by deleveraging, that is borrowing a sufficiently high amount such that subsequent repayment reveals the presence of unobservable income. When uncertainty is higher, good borrowers pay an adverse selection cost through a higher interest rate because bad borrowers could default, and asymmetric information is not always resolved.

Keywords: Adverse selection; Collateral; Credit score; Reputation; Signaling (search for similar items in EconPapers)
JEL-codes: D82 G32 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:183:y:2019:i:c:p:183-212

DOI: 10.1016/j.jet.2019.06.001

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