Endogenous capital market imperfections, human capital, and intergenerational mobility

In this paper, capital market imperfections are endogenized considering an adverse selection problem between banks and borrowers. We develop a growth model with linear OLG wealth dynamics, where agents are heterogeneous in terms of observable wealth and ability, which is private information. We show that banks react to this informational asymmetry by granting higher loans to talented borrowers. This, in turn, helps poor and talented agents to become educated and catch up with the rich agents. Furthermore, the credit market friction leads to greater human capital accumulation.