On the optimality of credit rationing
Abstract
"Can an equilibrium in the credit market be shown to exhibit credit rationing?" This thesis rigorously formalizes a theoretical model of the credit market and uses it to show the existence of a equilibrium where it is indeed optimal for lenders to practice rationing. We assume that the lender's source of funds lie in her deposits which are neither exogenous nor inexhaustible. In other words, lender's facing falling deposits will be forced to cut back on their lending. In a significant variation from the current literature, the supply side of the credit market is explicitly modeled. In order to more accurately reflect the reality in the credit market, this thesis introduces the assumption that deposits are the lender's source of funds. The lender, therefore, actually has control over her supply of deposits through her control of the interest rate charged on the loans she makes. A study of the conditions required to obtain a rationing equilibrium in both the basic model as well as the extended model and their interpretations is undertaken. The endogenization of the lender's source of funds is shown to have a significant impact. This thesis also provides a comparative static analysis of the impact of changes in various parameters like the "safe" rate of interest, amount borrowed and the debt equity ratio on the nature of the equilibrium. It is found that the impact of changes in these parameters on the equilibrium rate of interest depend crucially on the information set of the lender. This thesis shows that non-rationing equilibria are possible as well when certain conditions are not met and analyzes these non-rationing equilibria. The possibility of regime shifts from rationing to non-rationing equilibria is explored. Finally, this thesis provides numerical examples of the models by assuming different forms for the distribution and solving the models using them. Using normal distributions with different characteristics, we show that the probability distribution function assumed by the lender over the population determines the cut off probability and when faced with changes in the exogenous parameters, the lender will reset the optimal interest rate so as to keep the cut off probability constant. The optimal cut off probability changes only in response to a change in the distribution function itself. All these results taken together point to the vital importance of the information set the lender has over the population--something that has been ignored in the current literature.
Degree
Ph.D.
Advisors
Carlson, Purdue University.
Subject Area
Finance|Economic theory|Banking
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