Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/210787
Authors: 
Ahnert, Toni
Kuncl, Martin
Year of Publication: 
2019
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2019-47
Abstract: 
We examine insurance against loan default when lenders can screen in primary markets at a heterogeneous cost and learn loan quality over time. In equilibrium, low-cost lenders screen loans, but some high-cost lenders insure them. Insured loans are risk-free and liquid in a secondary market, while uninsured loans are subject to adverse selection. Loan insurance reduces the amount of lemons traded in the secondary market for uninsured loans, improves liquidity, and lowers lending standards. This pecuniary externality implies insufficient loan insurance in the liquid equilibrium. Therefore, a regulator achieves constrained efficiency by imposing a Pigouvian subsidy on loan insurance.
Subjects: 
Financial institutions
Financial markets
Financial system regulation andpolicies
JEL: 
G01
G21
G28
Document Type: 
Working Paper

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