Endogenous Leverage and Advantageous Selection in Credit Markets

Plamen T. Nenov

The Review of Financial Studies, 2017, vol. 30, issue 11, 3888-3920

Abstract: I study asset price amplification in an asymmetric information model. Entrepreneurs issue debt to finance investments in a physical asset. They have private information about their success probabilities. For a given debt level, higher asset prices require entrepreneurs to invest more of their own funds. This makes bad entrepreneurs more reluctant to mimic good ones; as a result, good entrepreneurs increase their equilibrium leverage and invest more, and this amplifies the initial asset price increase. This model generates predictions about the credit market that are qualitatively consistent with existing evidence. Received April 24, 2015; editorial decision June 15, 2016 by Editor Itay Goldstein.

JEL-codes: E22 E44 G32 (search for similar items in EconPapers)
Date: 2017
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