Bank monitoring incentives under moral hazard and adverse selection
In this paper, we extend the optimal securitisation model of Pag\es [50] and
Possama\"i and Pag\es [51] between an investor and a bank to a setting
allowing both moral hazard and adverse selection. Following the recent approach
to these problems of Cvitani\'c, Wan and Yang [14], we characterise explicitly
and rigorously the so-called credible set of the continuation and temptation
values of the bank, and obtain the value function of the investor as well as
the optimal contracts through a recursive system of first-order variational
inequalities with gradient constraints. We provide a detailed discussion of the
properties of the optimal menu of contracts.
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