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An options-based model of equilibrium credit rationing

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This paper applies options theory to the model of equilibrium credit rationing developed by [Stiglitz, J.E., Weiss, A., 1981. Credit rationing in markets with imperfect information, American Economic Review, 71, 727–752.] by noticing that, given a standard debt contract and limited liability, the payoffs to the lender and the borrower when a loan is made involve a put and call option respectively. Information asymmetry is modelled using stochastic volatility option pricing methods. There are three advantages to the options approach. First, the well-known comparative statics of option pricing provide an alternative and immediate proof for many of Stiglitz and Weiss' results. Secondly, the framework accommodates several theoretical extensions to the basic results. Finally, the approach allows an assessment of the empirical significance of equilibrium credit rationing, since the model is easily parameterised. Simulations of the model suggest that rationing is unlikely to be significant at the collateral levels observed in the U.S and U.K. small commercial loan market.

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Citation

Mason, R.A. (1998) An options-based model of equilibrium credit rationing Journal of Corporate Finance, 4, (1), pp. 71-85. (doi:10.1016/S0929-1199(97)00010-2).

More information

Published date: 1998
Keywords: equilibrium credit rationing, option pricing, stochastic volatility

Identifiers

Local EPrints ID: 33006
URI: http://eprints.soton.ac.uk/id/eprint/33006
ISSN: 0929-1199
PURE UUID: 51f86491-62d0-4e8f-bf40-b9caa4a33c0b

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Date deposited: 21 Jun 2007
Last modified: 17 Jul 2017 15:54

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Contributors

Author: R.A. Mason

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