Adverse selection as a barrier to entry in the banking industry

Giovanni Dell'Ariccia, Ezra Friedman, Robert Marquez

    Research output: Contribution to journalArticlepeer-review

    130 Scopus citations

    Abstract

    Banks offering credit to borrowers are faced with uncertainty about their creditworthiness. If banks obtain information about borrowers after lending to them, they are able to reject riskier borrowers when refinancing. Potential entrant banks will face an adverse-selection problem stemming from their inability to distinguish new borrowers from old borrowers who have been rejected by their previous bank. We analyze the effects of asymmetric information on the market structure of the banking industry. We characterize the equilibrium under Bertrand competition with two banks, and show that an equilibrium where a third bank enters does not exist (blockaded entry).

    Original languageEnglish (US)
    Pages (from-to)515-534
    Number of pages20
    JournalRAND Journal of Economics
    Volume30
    Issue number3
    DOIs
    StatePublished - 1999

    ASJC Scopus subject areas

    • Economics and Econometrics

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