Consider the financial-market imperfection model with asymmetric information. The firm needs one unit of capital to...

  

 

 

 

 

 

 

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Consider the financial-market imperfection model with asymmetric information. The firm needs one unit of capital to start a project that will produce y distributed uniformly over [0,2]. The firm owns W <1, and needs to borrow 1-W from the bank. There are infinite number of banks providing infinite amount of capital. The risk-free interest is r. We assume >1+r. 1) Suppose both the firm and the bank can observe y perfectly. Can you propose a feasible contract that makes borrowing possible? 2) Suppose the bank can only observe y with a cost C. Can you propose a feasible contract that makes borrowing possible? You can make your own assumptions on parameter values. 3) Based on your answer to 2), mark the area in a W-y diagram that represents the collection of (W, y) value combinations with which an investment project will be funded. Consider the financial-market imperfection model with asymmetric information. The firm needs one unit of capital to start a project that will produce y distributed uniformly over [0,2]. The firm owns W <1, and needs to borrow 1-W from the bank. There are infinite number of banks providing infinite amount of capital. The risk-free interest is r. We assume >1+r. 1) Suppose both the firm and the bank can observe y perfectly. Can you propose a feasible contract that makes borrowing possible? 2) Suppose the bank can only observe y with a cost C. Can you propose a feasible contract that makes borrowing possible? You can make your own assumptions on parameter values. 3) Based on your answer to 2), mark the area in a W-y diagram that represents the collection of (W, y) value combinations with which an investment project will be funded.

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1 With perfect information The firm gets a loan of 1W from the bank at interest rate r If ... View the full answer