Collateral is a widely used, but not well understood, debt-contracting feature. Two broad strands of theoretical literature explain collateral as arising from the existence of either ex ante private information or ex post incentive problems between borrowers and lenders. However, the extant empirical literature has been unable to isolate each of these effects. This paper attempts to do so using a credit registry that is unique in that it allows the researcher to have access to some private information about borrower risk that is unobserved by the lender. The data also include public information about borrower risk, loan contract terms, and ex post performance for both secured and unsecured loans. The results suggest that the ex post theories of collateral are empirically dominant although the ex ante theories are also valid for customers with short borrower-lender relationships that are relatively unknown to the lender.
JEL classification: G21, D82, G38
Key words: collateral, asymmetric information, banks
The authors thank the following for helpful comments and suggestions: an anonymous referee, Martin Brown, Marco Da Rin, Hans Degryse, Mark Flannery, Mariassunta Giannetti, Simon Kwan, Patrick Legros, Judit Montoriol-Garriga, Jan Krahnen, Bent Vale, Bas Werker, and Feng Wu. They also thank conference and seminar participants at the 2010 Allied Social Science Associations meetings, the 2009 European Finance Association meetings, the 2009 Financial Intermediation Research Society meetings, the 2009 Financial Management Association meetings, the conference "Business Models in Banking: Is There a Best Practice?" at Bocconi University, Pennsylvania State University, Sveriges Riskbank, and Tilburg University. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
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