Credit Rationing - Other Contributions

Other Contributions

The contribution of Stiglitz and Weiss was very crucial in addressing this important market outcome. It was one of a series of papers to address the important phenomenon of adverse selection in economics, pioneered by the classic study of the lemon problem in used car markets by George Akerlof, and celebrated by the paper by Michael Rothschild and Stiglitz on adverse selection in the insurance market. Many important studies followed their example, some with competing results, and extended the issue of credit rationing to further domains.

Before we go on discussing those studies, it is interesting to note that the first paper to treat credit rationing as a possible equilibrium phenomenon caused by adverse selection was by Dwight Jaffee and Thomas Russell in 1976. In their model, low quality borrowers would like to "masquerade" as high quality in order to get lower rates, and a separating equilibrium (that is, with different contracts offered to the two types) entails lower rates, but also lower loans, for the high types. This approach did not become popular however, as the pooling equilibrium (both types offered the same contract), which implies credit rationing, is not sustainable; a pooling contract offered to both types that will be accepted by both types and give non-negative profits to the banks can be dominated (generate higher profits) by a contract with lower interest and loan amount, which will only be preferred by the high quality types, who will drop the pooling contract, making it unprofitable for the banks. So focus has shifted on applications that allow for stable equilibrium rationing.