A Theory of Progressive Lending

Dyotona Dasgupta and Dilip Mookherjee

No 310, Working papers from Centre for Development Economics, Delhi School of Economics

Abstract: We characterize Pareto efficient long term ‘relational’ lending contracts with one-sided lender commitment, to finance specific investments and smooth intertemporal consumption of a borrower who cannot commit to repaying loans. The borrower can save and accumulate assets, and has strictly concave preferences over consumption. For borrowers with initial wealth above a threshold, the first-best is sustainable with a stationary contract. For poorer agents, there is perpetual but shrinking underinvestment which disappears in the long run. Borrowing, investment and wealth grow and converge to the first-best threshold. Optimal allocations can be implemented by backloaded ‘progressive’ lending: a sequence of one period loans of growing size. Increased borrower bargaining power raises short run consumption and investment, with no long term effects. We discuss extensions to incorporate random productivity shocks.

JEL-codes: D86 G21 O16 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2020-07
New Economics Papers: this item is included in nep-mfd
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Journal Article: A theory of progressive lending (2023)
Working Paper: A Theory of Progressive Lending (2020)
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