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Consider the two-period model with asymmetric information. Households deposit, D, in financial intermediaries (banks) and are paid the risk-free rate, r. Households take loans, L,
Consider the two-period model with asymmetric information. Households deposit, D, in financial intermediaries (banks) and are paid the risk-free rate, r. Households take loans, L, from banks and pay the lending rate, rl. A fraction of households, p, pay back their debt, and a fraction, 1 p, only pay back a quarter of the loan. Ex-ante banks know the fraction that repay, p, but cannot identify the individual households. Banks lend out all deposits. However, banks maintain positive profits, , such that =qD where 0 < q < 1 is some constant. (a) Write down the banks profit condition. (b) What is the lending rate, rl, that banks will charge? (c) How does the lending rate change with an increase in p
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