Dependence of Equilibrium Credit Rationing on the Nature of Loan Insurance : The Spillover Effects of Asymmetric Information

This paper shows how imperfect information in the insurance market can produce equilibrium credit rationing in the credit market even when the market for credit is symmetrically informed. This occurs if the insurance company uses either endogenous premiums or endogenous coverage as a response to the moral hazard problems associated with asymmetric information. The fact that asymmetric information in one market can have spillover effects into another adds to the importance of established asymmetric information results. The paper begins by showing how the credit rationing result of Stiglitz and Weiss (1981) is sensitive to the existence of risk assessment, and how a rise in interest rates may actually produce 'favourable selection' when the bank is able to differentiate between risks. The paper then shows how the introduction of endogenous insurance contracts may result in credit rationing in the credit market even when risk assessment is available to banks