Contract Design in Mortgage Loans under Asymmetric Information: The Analysis When Firms are Short of Mortgage Assets

Abstract

By focusing on how the contracts are influenced by the client firms' mortgage assets, the paper develops a principal-agent model to analyze the contracts of mortgage loans under moral hazard framework, and then characterizes the optimal contract. The results show that there exists credit rationing under moral hazard as well as adverse selection. Furthermore, there exists a threshold value of mortgage assets under asymmetric information: when firms' mortgage assets are more than this threshold value, the loans are constant; however, when firms' mortgage assets are lower than this threshold value, the loans have positive correlation with the mortgage assets. It gives an explanation why the small and medium-sized enterprises (SMEs) often face the credit rationing.