Project risk neutrality in the context of asymmetric information

Abstract

Using the modeling framework of Stiglitz and Weiss (1981), we show that – perhaps surprisingly – there is no influence of average project risk on the capital market equilibrium. The savings interest rate fully determines the amount of credit rationing and the nature of an equilibrium (adverse selection, two-prices etc.). This rate is, in turn, fully determined by the relative probabilities of success of firms’ projects (and, thus, repayment of their debt). Hence, making capital markets overall “less risky”, which may for example be the case when financial markets become greener, does not alleviate concerns of asymmetric information. The result holds both for cases of hidden information and for those of hidden actions.