Capital Accumulation in the Presence of Informal Credit Contracts: Does the Incentive Mechanism Work Better than Credit Rationing Under Asymmetric Information?

Credit markets with asymmetric information often prefer credit rationing as a profit maximizing device. This paper asks whether the presence of informal credit markets reduces the cost of credit rationing, that is, whether it can alleviate the impact of asymmetric information based on the available information. We used a dynamic general equilibrium model with heterogenous agents to assess this. Using Indian credit market data our study shows that the presence of informal credit market can reduce the cost of credit rationing by separating high risk firms from the low risk firms in the informal market. But even after this improvement, the steady state capital accumulation is still much lower as compared to incentive based market clearing rates. Through self revelation of each firm's type, based on the incentive mechanism, banks can diversify their risk by achieving a separating equilibrium in the loan market. The incentive mechanism helps banks to increase capital accumulation in the long run by charging lower rates and lending relatively higher amount to the less risky firms. Another important finding of this study is that self-revelation leads to very significant welfare improvement, as measured by consumptiuon equivalence.

An Equilibrium Model of Lawmaking

This paper embeds a model of lawmaking in an equilibrium framework in which the demand for trials is rationed by court delay. The lawmaking process depends on a combination of selective litigation, judicial bias, and precedent. The steady state equilibrium of the model determines both the length of delay and the distribution of legal rules. Comparative statics show that an increase in the supply of trials reduces delay but may or may not increase the proportion of efficient rules. An increase in the fraction of judges biased in favor of the efficient rule, however, will likely improve efficiency on both counts.