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Partial Credit Guarantees Discussions Quy-Toan Do (DECRG) Summary of the papers Arping et al. (2008) • Interplay of credit guarantees/cofunding in the standard insuranceagency tradeoff • Propose an optimal contract Benavides and Huidobro (2008) • Credit guarantees when private lenders are risk-averse • Structural estimation of optimal level of credit guarantee The canonical model A tension between agency and insurance The model: • A project has stochastic returns • Entrepreneur can exert effort to increase probability of success • Need to reward effort by giving prize if project succeeds: because of limited liability, there is a cap on interest rates; possibility of credit rationing Thus: a low return confounds bad luck and lack of effort How severely to punish the entrepreneur if a low return is realized? Tradeoff between punishing bad behavior and unlucky outcome. Remaining questions Why government-sponsored schemes? • Credit rationing? Arping et al. (2008) What is the government comparative advantage? • Private lenders are risk-averse? Benavides and Huidobro (2008) Why not securitization? • Externalities? Is PCG the best scheme in terms of efficiency and targeting? Reassessment of tradeoff, optimal contract A “credit rationing” story? Arping et al. (2008): existence of institution is taken as given What is the comparative advantage of the government or any institution to provide this service? In moral hazard case: co-funding always the optimal solution (pure subsidy) A “risk-averse banks” story? Benavides and Huidobro (2008) Why is a government agency better insurer of banks than the private market? Moral hazard – Insurance tradeoff is now moved to the contract between private banks and the government agency In the long-run, whether government-backed guarantee is targeted to lenders or borrowers is irrelevant Externality One avenue for further research: some firms generate large spillovers not internalized by private investors • Employment (social stability – consumption – votes) • Environment How does the government intervention affects the agency-insurance tradeoff? Tradeoff between targeting and distortion (moral hazard – adverse selection)