Oligopoly with Asymmetric Information: Differentiation in Credit Markets


by Udo Schmidt-Mohr (Universitat des Saarlandes)
&
J. Miguel Villas-Boas (University of California at Berkeley)

ABSTRACT

This paper studies an oligopoly model with asymmetric information and product differentiation. The analysis focuses on credit markets (other suitable applications would be labor and insurance markets). As usual, information is assumed to be asymmetric with respect to customer characteristics which directly affect profits of banks. We analyze the impact of horizontal differentiation (which serves an an index for the degree of competition among banks) on the loan granting practices of banks.

In particular, with more differentiation (less competition) banks may screen credit applicants less intensively in equilibrium. As a result, we establish that welfare need not be monotonically declining as competition becomes less intense. Finally, we establish that profits derived from the high type entrepreneurs are higher under asymmetric information with respect to loan quality than under symmetric information. Contracts are always separating for very competitive markets, while they may be pooling for less competitive markets.