Memory in Contracts: The experience of the EBRD (1991-2003)

Abstract

The objective of this paper is to identify the role of memory in repeated contracts with moral hazard in financial intermediation. We use an original dataset from the European Bank for Reconstruction and Development to test a basic model with repeated moral hazard. To capture the role of memory, we need to control for the adverse selection effect. We propose a simple empirical method to achieve it. Our results unambiguously isolate the effect of memory in the bank's lending decisions.