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Adverse Selection and Search Frictions in Corporate Loan Contracts

Beyhaghi, Mehdi and Mahmoudi, Babak and Mohammadi, Ali (2013): Adverse Selection and Search Frictions in Corporate Loan Contracts.

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We provide empirical evidence of both (1) price dispersion and (2) credit rationing in the corporate loan market. We argue that these properties are caused by two factors: an adverse selection resulting from the information asymmetry between lenders and borrowers, and search frictions in matching borrowers with lenders. We develop a model of loan markets in which lenders post an array of heterogeneous contracts, then borrowers tradeoff terms of loan contracts and matching probability between themselves. We show that a unique separating equilibrium exists where each type of borrower applies to a certain type of contract.

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