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Investment shocks and inequality dynamics

Gokmen, Gunes LU and Morin, Annaig (2021) In Economic Modelling 94. p.570-579
Abstract

We explore the dynamics of income and income inequality under asymmetric information in credit markets. Within a stochastic overlapping-generations framework, we study the investment decision of entrepreneurs with heterogeneous abilities. Under information asymmetry, banks do not observe entrepreneurial ability and offer a single pooled loan contract to all entrepreneurs. We show that, following a negative investment shock, the average quality of the entrepreneur pool improves and banks optimally react by lowering the pooled borrowing rate. This reduction in the borrowing rate mitigates the drop in entrepreneurs' income. Consequently, after a negative investment shock, income inequality decreases less compared to the case of full... (More)

We explore the dynamics of income and income inequality under asymmetric information in credit markets. Within a stochastic overlapping-generations framework, we study the investment decision of entrepreneurs with heterogeneous abilities. Under information asymmetry, banks do not observe entrepreneurial ability and offer a single pooled loan contract to all entrepreneurs. We show that, following a negative investment shock, the average quality of the entrepreneur pool improves and banks optimally react by lowering the pooled borrowing rate. This reduction in the borrowing rate mitigates the drop in entrepreneurs' income. Consequently, after a negative investment shock, income inequality decreases less compared to the case of full information. Our findings therefore suggest that information asymmetry lessens the fluctuations in income inequality.

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author
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organization
publishing date
type
Contribution to journal
publication status
published
subject
keywords
Credit markets, Income inequality, Information asymmetry, Investment
in
Economic Modelling
volume
94
pages
10 pages
publisher
Elsevier
external identifiers
  • scopus:85080874360
ISSN
0264-9993
DOI
10.1016/j.econmod.2020.02.003
language
English
LU publication?
yes
id
da041f28-0e13-498c-b5e4-93ef19511125
date added to LUP
2020-03-24 15:26:38
date last changed
2021-01-04 16:09:19
@article{da041f28-0e13-498c-b5e4-93ef19511125,
  abstract     = {<p>We explore the dynamics of income and income inequality under asymmetric information in credit markets. Within a stochastic overlapping-generations framework, we study the investment decision of entrepreneurs with heterogeneous abilities. Under information asymmetry, banks do not observe entrepreneurial ability and offer a single pooled loan contract to all entrepreneurs. We show that, following a negative investment shock, the average quality of the entrepreneur pool improves and banks optimally react by lowering the pooled borrowing rate. This reduction in the borrowing rate mitigates the drop in entrepreneurs' income. Consequently, after a negative investment shock, income inequality decreases less compared to the case of full information. Our findings therefore suggest that information asymmetry lessens the fluctuations in income inequality.</p>},
  author       = {Gokmen, Gunes and Morin, Annaig},
  issn         = {0264-9993},
  language     = {eng},
  pages        = {570--579},
  publisher    = {Elsevier},
  series       = {Economic Modelling},
  title        = {Investment shocks and inequality dynamics},
  url          = {http://dx.doi.org/10.1016/j.econmod.2020.02.003},
  doi          = {10.1016/j.econmod.2020.02.003},
  volume       = {94},
  year         = {2021},
}