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Collateralisation shifts risk towards borrower – A formal proof

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Abstract

This article formally proves that if, in a standard debt contract, collateral is increased and interest is decreased simultaneously in a way that keeps expected repayment constant, then for the borrower the resulting probability distribution of payoff is a mean preserving spread of the original one. Together with a theorem from [RS70] the consequence is that risk-averse borrowers prefer loans with little collateral. The result has numerous implications on the evaluation and the contracting module of lending theory.

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Copyright information

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020

Authors and Affiliations

  1. 1.Universität RegensburgRegensburgGermany

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