Dynamic Adverse Selection and Belief Update in Credit Markets

Jang, Inkee and Kang, Kee-Youn ORCID: 0000-0003-4398-6079 (2025) Dynamic Adverse Selection and Belief Update in Credit Markets JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS, 60 (4). pp. 1994-2025. ISSN 0022-1090, 1756-6916

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Abstract

We develop a dynamic model of debt contracts with adverse selection. Entrepreneurs borrow investment goods from lenders to run businesses whose returns depend on entrepreneurial productivity and common productivity. Entrepreneurial productivity is the entrepreneur's private information, and lenders construct beliefs about entrepreneurial productivity based on the entrepreneur's business operation history, common productivity history, and the terms of the contract. The model provides insights into the dynamic and cross-sectional relations between firm age and credit risk, persistency of the effects of a productivity shock, cyclical asymmetry of the business cycle, slow recovery after a crisis, and constructive and destructive economic downturns.

Item Type:	Article
Uncontrolled Keywords:	3502 Banking, Finance and Investment, 35 Commerce, Management, Tourism and Services, 3507 Strategy, Management and Organisational Behaviour
Depositing User:	Symplectic Admin
Date Deposited:	10 Sep 2026 11:04
Last Modified:	06 Oct 2026 15:53
DOI:	10.1017/S0022109024000243
Related Websites:	Author Publisher
URI:	https://livrepository.liverpool.ac.uk/id/eprint/3201224
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