Finance Seminar with Felipe Varas, Duke University

The Department of Finance is proud to announce the upcoming seminar with Felipe Varas, Fuqua School of Business, Duke University.

Felipe Varas will present:

A Dynamic Theory of Learning and Relationship Lending

ABSTRACT
We introduce learning into a banking model to study the dynamics of relationship lending. In our model, an entrepreneur chooses between bank and market financing. Bank lending facilitates learning over time, but it subjects the borrower to the downside of hold-up cost. We construct an equilibrium in which the entrepreneur starts with bank financing and subsequently switches to the market, and we find conditions under which this equilibrium is unique. Our model generates several novel results: 1) Endogenous zombie lending, i.e. the bank is willing to roll over loans known to be bad for the prospect of future loan sales. 2) Short maturity could encourage zombie lending and deteriorate credit quality; and 3) the hold-up cost may increase or decrease with the length of the lending relationship.