Information Acquisition Under Uncertainty in Credit Markets

Abstract

This article studies information acquisition through investment in improved risk assessment technology in competitive credit markets. A technology has two attributes: its ability to screen in productive borrowers, and its ability to screen out unproductive borrowers. The two attributes have fundamentally different effects on acquisition incentives and the structure of equilibrium informational externalities between lenders. The article also studies how uncertainty associated with the quality of superior technology affects information acquisition incentives. Uncertainty influences information acquisition even with risk-neutral banks. Increased uncertainty may raise or dampen incentives, depending on whether uncertainty is, respectively, about screening out or screening in quality. This article studiesinformation acquisition through investment inimproved risk assessment technology in competitive credit markets. Information acquisition or screening by banks facilitates the rating of creditworthiness and drives the ability to compete in deregulated financial markets. 1 Although improvements in information technology have augmented the ability to screen borrowers and manage risk, the adoption of enhanced screening technologieshas been uneven. 2 The centralityand continuation of the information technology revolution forces closer scrutiny of the decision to adopt new technology. It is generally argued that more widespread use of better information processing technology will benefit borrowers, improve credit allocation and enhance banks’ competitive positions. But will new information processing products or platforms be necessarily adopted, if they are costly?