Optimal Loan Interest Rate Contract Design

Optimal Loan Interest Rate Contract Design This paper analyzes optimal loan interest rate contracts under conditions of risky, symmetric information for one-period (static) and multi-period (dynamic) models. The optimal loan interest rate depends upon the volatility of, and co-variation among the market interest rate, borrower collateral, and borrower income, as well as the time horizon and the risk preferences of lenders and borrowers. For a risk-averse borrower with stochastic collateral, variable interest rate contracts are, in general, Pareto optimal. For plausible assumptions, the optimal loan interest rate for the multi-period model often exhibits “muted” responses to changes in market interest rates, making fixed rate loans a reasonable approximation for the optimal loan. Hence, in the absence of optimal contracts, long-term (short-term) borrowers tend to prefer fixed rate (variable) contracts. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Real Estate Finance and Economics Springer Journals

Optimal Loan Interest Rate Contract Design

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Kluwer Academic Publishers
Copyright © 2003 by Kluwer Academic Publishers
Economics; Regional/Spatial Science; Financial Services
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