Bester, Helmut, "The Role of Collateral in Credit Markets with Imperfect Information", European Economic Review, Vol. 31, No. 4, (June 1987), pp. 887-899.

Abstract: The paper analyzes the structure of credit market equilibrium under imperfect information. Collateralization and credit rationing are compared as alternative means to cope with problems of adverse selection and moral hazard. It is shown that lenders may use collateral as a self-selection and incentive mechanism. Rationing occurs only if the borrowers' collaterizable wealth is too small to allow perfect sorting or to create sufficiently strong incentives. Whenever there is rationing in an equilibrium, some borrowers are charged the maximum amount of collateral.