Credit Market Functions Flashcards
The phenomenon that some consumers pay a higher interest rate when they borrow than the interest rate they receive when they lend is best described as an example of a
Credit market imperfection
Asymmetric Information means that
That some market participants have more information than others.
Limited commitment means that
One cannot credibly promise something, therefore there is always the potential for a borrower to default on a loan.
What is meant by Collateral? What does a collateral constraint do?
This is an asset that can be seized if the borrower defaults, a loan is normally valued against the value of the borrowers house. A collateral constraint also provides an incentive for the borrower not to abscond on their debts.
In the two-period model, the nature of the asymmetric information is that
Only the borrower knows whether they are a good borrower or a bad one; essentially they know whether they will pay back / default on a loan.
What is an interest rate spread?
This is the difference between lending and borrowing interest rates.
In the model with asymmetric information in the credit market, a decrease in the fraction of bad borrowers in the population has what effect on the interest rate spread?
Reduces the interest rate spread.
In what scenario is collateral not used?
Credit card lending. This therefore makes this a unsecured loan - normally based off previous debt repayments / credit score.
If the value of collateral falls for a consumer, what happens to consumption?
Current consumption falls only if the collateral constraint binds.
The negative impact of the loss of value of collateralized assets is due to
Limited commitment
What are the characteristics of the bank within an asymmetric model?
Essentially the banks borrow at a low interest rate, then lend at a higher rate to potential borrowers while binding a collateral constraint to their agreement.
