In an overlapping generations economy, households (lenders) fund risky investment projects of firms (borrowers) by drawing up loan contracts on the basis of asymmetric information. An optimal contract entails either the issue of only debt or the issue of both debt and equity according to whether...

We consider a neoclassical growth model with risky investment projects in which a borrower's (an investor's) risk type is private information. Our innovation is to determine jointly the equilibrium loan contract and the economy's growth path and the steady state capital stock. We show that as...