Three essays on asymmetric information and imperfect credit markets

Date of Completion

January 2005


Economics, General




The importance of credit market imperfections due to asymmetric information is multidimensional in the context of overall economic development. The inability of the banks to measure the degree of risk of defaults leads to credit rationing in most of the cases. Administered interest rates coupled with the lack of a proper mechanism to measure the degree of risk reduces the banks' incentives to extend loans and reduces overall efficiency. Under such circumstances banks ration credit in order to reduce risk. As we see from the experience of most of the developing nations in general, and, India in particular, such rationing in the formal market creates a spill over of the excess demand to the informal sector. Given this backdrop this dissertation tries to focus mainly on the impact of credit rationing on capital accumulation, economic growth and labor market imperfections when informal markets are present. ^ We set up a dynamic general equilibrium framework for our study. Two different financial regimes are considered in our model to propose an alternative incentive mechanism to credit rationing. To quantify our models we used Indian households level data, collected by AERC/U and collated by IIMA, India, for the period of 1997-98 to 1999-00. ^ In our first essay, we ask whether the presence of informal credit markets can reduce the cost of credit rationing, that is, whether it can alleviate the impact of asymmetric information based on the available information. ^ Our second essay examines whether the presence of informal credit markets reduces the cost of credit rationing in terms of growth. We assume that firms are heterogenous with different degrees of risk and households invest in human capital development. ^ In our third essay, we measure the lower steady state equilibrium outcome in human capital development from the incidence of child labor in India. (Abstract shortened by UMI.)^