Single-name Credit Risk, Portfolio Risk and Credit Rationing

In the Stiglitz-Weiss (1981) adverse selection model, pure credit rationing cannot arise in equilibrium. We show that this is due to the fact that single-name risks are independent and a well-diversified portfolio contains no risk. We introduce non-diversifiable macroeconomic risk to the model and show that risk-averse lenders possibly ration credit. Welfare analysis shows that an interest rate ceiling is potentially welfare enhancing and that equilibrium overinvestment can occur.