Collateral and Competitive Equilibria with Moral Hazard and Private Information

ABSTRACT The authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications. Both moral hazard and adverse selection are considered. The principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts. Specifically, some well‐known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept. Two somewhat surprising results emerge. First, high‐quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits. Second, high‐quality borrowers may put up more collateral.