Does Collateral Help Mitigate Adverse Selection? A Cross-Country Analysis

What is it about?

In this paper, we empirically investigate whether collateral mitigates adverse selection problems in a loan market. Theory predicts a negative relation between the presence of collateral and the interest spread of a loan. However, bankers’view and most empirical evidence contradict this prediction and support the observed-risk hypothesis instead. We provide new evidence from a sample of 4,940 bank loans from 31 countries. We test whether the degree of information asymmetry affects the positive link between collateral and the loan spread and find that a greater degree of information asymmetry reduces this positive relation. This finding provides support for both the adverse selection and observed-risk hypotheses.

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