When Opposites Attract: Is the Assortative Matching Always Positive?

This paper shows that the positive assortative matching of Ghatak (1999) and Van Tassel (1999) is not a general result and always depends on the distribution of safe and risky types. Some new implications are: (i) borrowers may be better off by forming mixed groups. (ii) a mixed pooling equilibrium is possible when homogeneous pooling equilibria do not exist, and even when the reservation income of borrowers is equal to zero.joint liability lending; assortative matching; screening

Too much waste, not enough rationing: the failure of stochastic, competitive markets

There are good reasons why sellers often post prices before the realization of demand shocks. We study whether equilibrium prices chosen ex ante coincide with the ex-ante prices that maximize expected aggregate surplus. The main result is that even in the competitive limit there is a divergence. Waste is excessive and entry decisions are distorted. The problem is that for competitive firms to sell in low-demand states involves a costly sacrifice of high-state revenue

When Opposites Attract: Is the Assortative Matching Always Positive?

This paper shows that the positive assortative matching of Ghatak (1999) and Van Tassel (1999) is not a general result and always depends on the distribution of safe and risky types. Some new implications are: (i) borrowers may be better off by forming mixed groups. (ii) a mixed pooling equilibrium is possible when homogeneous pooling equilibria do not exist, and even when the reservation income of borrowers is equal to zero

Is it better to be mixed in group lending?

This paper shows that, in a group-lending environment characterized by positive assortative matching, a microfinance institution can achieve a Pareto improvement by promoting negative matching among borrowers. Some new implications are: i) borrowers may be better off under mixed groups; ii) a heterogeneous group lending equilibrium is possible even when individual or homogeneous group equilibria do not exist

Is it better to be mixed in group lending?

This paper shows that, in a group-lending environment characterized by positive assortative matching, a microfinance institution can achieve a Pareto improvement by promoting negative matching among borrowers. Some new implications are: i) borrowers may be better off under mixed groups; ii) a heterogeneous group lending equilibrium is possible even when individual or homogeneous group equilibria do not exist

Take the money and run: making profits by paying borrowers to stay home

Can a bank increase its profit by subsidizing inactivity? This paper suggests this may occur, due to the presence of hidden information, in a monopolistic credit market. Rather than offering credit in a pooling contract, a monopolist bank can sort borrowers through an appropriate subsidy to inactivity. Under some conditions, sorting may avoid the collapse of the market and increases the welfare of everybody. The bank increases its profits, good borrowers benefit from lower interest rates and bad potential borrowers from the subsidy. The subsidy policy however implies a cross subsidy between contracts and this is possible only under monopoly

Too Much Waste: A Failure of Stochastic, Competitive Markets

The equilibrium of a competitive market in which firms must choose prices ex ante and demand is stochastic is shown to be second-best inefficient. Even under risk neutrality, equilibrium price exceeds the welfare-maximising predetermined price. Competition tends to eliminate rationing, but at the greater welfare cost of creating excess capacity. Entry incentives are also distorted. In low states, entrants obtain a share of revenue without increasing consumption, giving rise to a version of the common pool problem. In high states, firms do not appropriate the consumer surplus gained from marginal reductions in rationing. As a result of these o¤setting externalities, the number of firms may be excessive or insufficient. Inefficiency arises whether or not the rationing rule is efficient

Too Much Waste: A Failure of Stochastic, Competitive Markets

The equilibrium of a competitive market in which firms must choose prices ex ante and demand is stochastic is shown to be second-best inefficient. Even under risk neutrality, equilibrium price exceeds the welfare-maximising predetermined price. Competition tends to eliminate rationing, but at the greater welfare cost of creating excess capacity. Entry incentives are also distorted. In low states, entrants obtain a share of revenue without increasing consumption, giving rise to a version of the common pool problem. In high states, firms do not appropriate the consumer surplus gained from marginal reductions in rationing. As a result of these o¤setting externalities, the number of firms may be excessive or insufficient. Inefficiency arises whether or not the rationing rule is efficient

Too Little Lending: A Problem of Symmetric Information

In a simple model of the consumer credit market, we show that asymmetric information may enhance welfare relative to full information. The advantage of hidden types is that solvency and default constraints are relaxed, allowing beneficial lending. Prohibiting the use of observable information may therefore be efficient. It is also shown that rather than the nature of borrower heterogeneity, whether asymmetric information involves adverse or advantageous selection depends on the magnitude of default costs. Even when selection is adverse, lending and welfare may be higher under asymmetric information than under symmetric information

Too Little Lending: A Problem of Symmetric Information

In a simple model of the consumer credit market, we show that asymmetric information may enhance welfare relative to full information. The advantage of hidden types is that solvency and default constraints are relaxed, allowing beneficial lending. Prohibiting the use of observable information may therefore be efficient. It is also shown that rather than the nature of borrower heterogeneity, whether asymmetric information involves adverse or advantageous selection depends on the magnitude of default costs. Even when selection is adverse, lending and welfare may be higher under asymmetric information than under symmetric information