Problem 1. Consider a banking model with delegated monitoring. Markets are perfectly competitive. There is a...

 

Transcribed Image Text:

Problem 1. Consider a banking model with delegated monitoring. Markets are perfectly competitive. There is a large number of borrowers who lack the funds and a large number of lenders who have the funds. Each lender has k goods to lend. Each borrower can invest in one project which requires uk goods. Assume > 1 so that u lenders to fund one project. Investment return is risky and given by Jx₁μk prob. = 3/ 2μk prob. = where x₁ > 1 > 2 are the rates of return when project succeeds or fails respectively. The return is private information for the borrower. Other people have to incur a cost to monitor the outcome from investment. (a) With direct borrowing, what is the average gross rate of return for each lender? Explain. (b) With banking, what is the gross rate of return for each lender? Explain. Problem 1. Consider a banking model with delegated monitoring. Markets are perfectly competitive. There is a large number of borrowers who lack the funds and a large number of lenders who have the funds. Each lender has k goods to lend. Each borrower can invest in one project which requires uk goods. Assume > 1 so that u lenders to fund one project. Investment return is risky and given by Jx₁μk prob. = 3/ 2μk prob. = where x₁ > 1 > 2 are the rates of return when project succeeds or fails respectively. The return is private information for the borrower. Other people have to incur a cost to monitor the outcome from investment. (a) With direct borrowing, what is the average gross rate of return for each lender? Explain. (b) With banking, what is the gross rate of return for each lender? Explain.

Answer rating: 100% (QA)

aThe average gross rate of return for each lender is r1r22 This is because each lender can only lend ... View the full answer