Collateral, Heterogeneity in Risk Attitude and the Credit Market Equilibrium

Paper number: 97/02

Paper date: November 1996

Year: 1997

Paper Category: Discussion Paper


Guiseppe Coco*
University of Exeter and CEPR


This paper examines the argument that the availability of collateral rules out credit rationing. A model of the credit market with ex-ante asymmetric information and heterogeneous entrepreneurs' attitudes towards risk is set up. It is shown that, due to the interplay between project choice and entrepreneurs' preferences, using collateral as a signal to screen safer projects may prove impossible. Instead, a partially-separating two-contracts equilibrium with rationing at one contract emerges. Contrary to previous theoretical research and consistently with conventional wisdom and systematic evidence, the use of collateral is never negatively correlated with project risk.

First version: June 1996
This version: November 1996

JEL Classification Nos: D82, G14
Keywords: Collateral, credit rationing

Corresponding Author: Guiseppe Coco, Department of Economics, University of Exeter, Amory Building, Rennes Drive, Exeter, EX4 4RJ,Great Britain, tel:(44) 1392 263219, fax: (44) 1392 263242,