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Market-Based Solutions to Vital Economic Issues

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Market-Based Solutions to Vital Economic Issues
Research
Sep 28, 2018

Credit Markets and Relationship Capital

Abstract

I develop a theory of credit relationships in an economy subject to search frictions and limited enforceability. The model features a dynamic contracting problem embedded within a directed search equilibrium with aggregate and creditor-specific uncertainty. The interaction between search and agency frictions generates a slow accumulation of relationship capital and distorts the optimal allocation of credit along both intensive and extensive margins. A crisis characterized by a sizable destruction of lending relationships therefore leads to a significant contraction in credit and a sluggish recovery, consistent with the Great Recession. I calibrate the model to study aggregate and cross-sectional implications and analyze policies aimed at reviving bank lending.

Note: Working papers, including any findings, may differ from the final version chosen for publication in academic journals.

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