| Many financial products have state-contingent returns, with the probabilities of these states varying according to the buyer. In the case of loans, some borrowers are more likely to pay than others. It is up to the lender to decide if multiple contracts for different types of borrowers is incentive compatible, and profitable. The first chapter finds that small, uncollateralized loans, like those given by microfinance firms, can be profitable if they are accompanied by a high interest rate. As more collateral is pledged, loan sizes increase, and interest rates fall. The second chapter asks if adverse selection can account for the thin annuity market. Annuitants tend to be longer-lived than their non-annuitized counterparts, driving up the price on annuities. The model predicts a spike in annuity returns after age 80, accounting for the delay in annuitization by many retirees. The third chapter shows that adverse selection in the annuity market can create demand for employer-provided pensions. When all workers are pooled with the same contract, adverse selection is not a problem, and workers can earn a higher return on their retirement savings. It goes on to show that labor market conditions can explain a large part of the movement away from employer-provided defined benefit pensions. |
