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Models of optimal contract in lending: Evaluating the impact of diversified versus focused policies on riskiness of borrower base |
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| Affiliation: | 1. Department of Finance and Investment, College of Economics and Administrative Sciences, Al-Imam Mohammad Ibn Saud Islamic University (IMSIU), Riyadh 5701, Saudi Arabia;2. LARTIGE, ASTURIMA, University of Sousse, Tunisia;3. Indian Institute of Management (IIM) Bodh Gaya, Bodh Gaya, India;4. Lebow College of Business, Drexel University, Philadelphia, USA;5. Institute of Business Research, University of Economics Ho Chi Minh, Vietnam;1. Department of Industrial and System Engineering, Hosei University, Japan;2. School of Business, Aoyama Gakuin University, Japan;1. School of Economics and Management, Dongguan University of Technology, No. 251, Xue Yuan Rd., Dongguan, Guangdong, China;2. Department of Finance, College of Management, National Yunlin University of Science and Technology, No. 123, Sec.3, University Rd., Yunlin County, Taiwan |
| Abstract: | Empirical studies on bank lending policies have offered contradictory results regarding the impact of each of the two distinct lending policies of focused and diversification on riskiness of lender’s borrower base. This study first constructs a general model of contracts for lending under asymmetric information and characterizes the equilibrium outcomes under each of the two lending policies. It then demonstrates that the relative preferences of borrower groups towards bank loan plays a key role in determining if a lending policy switch between the two policies increases or decreases the riskiness of the bank’s borrower base. The results offer a rational explanation for the existing contradictory results in the empirical literature. |
| Keywords: | Asymmetric information Borrower risk Likelihood ratio measure of risk |
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