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1 Overview WORKSHEET OVERVIEW: Stiglitz Weiss 1981.xls
2 Stiglitz & Weiss (Discrete) Stiglitz & Weiss (discrete model for illustration)
3 Stiglitz & Weiss (Continuous) Stiglitz & Weiss (continuous model)
4 Model Description Formulas from Matthews & Thomson Book
5 Beta Distribution Beta Distribution
6 Formulas Beta Distribution Formulas Beta Distribution

khess WMS 12/02/2009 25891331.xls Overview Page 1


Stiglitz & Weiss (discrete model for illustration)
inspired by Matthews & Thompson (2008), 'The Economics of Banking', 2nd edition, Wiley, p. 122, Box 8.3
W $0.20 Wealth of investor to be invested
k $1.00 Investment required for project
L $0.80 Borrowing from bank
retproj 15.0% 150 project expected rate of return (%)
R=k*(1+retproj) $1.15 Expected payoff project
r 30.0% 300 Borrowing rate
δ 10.0% 100 Safe investment rate
r-δ 20% Borrowing / investing spread

Discrete projects
Exp.payoff Exp. payoff of Exp. Borrower Cut-off:
# of projects pi borrower i E(πi) bank per loan return (%) < or > δ E(πB)
3 30% $0.838 $0.312 319.00% > $0.94
5 40% $0.734 $0.416 267.00% > $2.08
10 50% $0.630 $0.520 215.00% > $5.20
12 60% $0.526 $0.624 163.00% > $7.49
15 70% $0.422 $0.728 111.00% > $10.92
36 80% $0.318 $0.832 59.00% > $29.95
59 90% $0.214 $0.936 7.00% <10.0% $-
100 95% $0.162 $0.988 -19.00% <10.0% $-
88 99% $0.120 $1.030 -39.80% <10.0% $-

Total E(πB): $56.58


Expect profit to bank as a function of cut-off probability p Cut-off 6
Cut-off p Offset in table p (cut-off) > 80.00%
E(πB,p) $301.20 99% 8
E(πB,p) $111.80 95% 7
E(πB,p) $56.58 90% 6
E(πB,p) $26.62 80% 5

Profit maximizing loan rate for bank

0.35

0.3

0.25

0.2

0.15

0.1
2
0.05 5%

0
Column
0 K 10 Column20
K Column
30 O 40 50 60

Cuf-off probabilities (p) as a function of loan rate


0.35

0.3

0.25
0.35

0.3

0.25

0.2

0.15

0.1

0.05 5%

0
-20% 0% Column
20%K Column
40% O 60% 80% 100%
Back to Overview

Histogram of projects Payoff Borrower vs. Payoff Bank


0 20 40 60 80 100 120
99%
30% 3 .
95%
40% 5 90%
Success probability of project

50% 10 80%
60% 12 70%
70% 15 60%
80% 36 50%

90% 59 40%

95% 100 30%


Exp.payoff Exp. payoff of
99% 88 borrower
$- i E(pi)
$0.20 bank per loan
$0.40 $0.60 $0.80 $1.00 $1.20 $1.40

Support lines
max profit line profit maximizing loan rate
0 56.58 0 5.00% 0
5.00% $57 56.58 5.00% 0.8
0.06 56.58 57.14 5.00% 0.81

Data Table
$56.58 80.00%
5% $57 0.8
6% $57 0.8
7% $57 0.8
8% $57 0.8
9% $57 0.8
10% $57 0.8
11% $57 0.8
12% $57 0.8
13% $57 0.8
14% $57 0.8
15% $57 0.8
16% $57 0.8
17% $57 0.8
18% $57 0.8
19% $57 0.8
20% $57 0.8
21% $57 0.8
22% $57 0.8
23% $57 0.8
24% $57 0.8
25% $57 0.8
26% $57 0.8
27% $57 0.8
28% $57 0.8
29% $57 0.8
30% $57 0.8
ayoff Bank

$0.80 $1.00 $1.20 $1.40


A B C D E F G
1 Stiglitz & Weiss (continuous model)
2 Inspired by Matthews & Thompson (2008), 'The Economics of Banking', 2nd edition, Wiley, p. 122, Box 8.3
3 W $0.20 Wealth of investor to be invested
4 k $1.00 Investment required for project
5 L $0.80 Borrowing from bank
6 retproj 15.0% 150 project expected rate of return (%)
7 R=k*(1+retproj) $1.15 Expected payoff project
8 r 19.0% 190 Borrowing rate
9 δ 10.0% 100 Safe investment rate
10 r-δ 9% Borrowing / investing spread
11
12 Cut-off probability as function of loan rate r - above this p borrower will invest W at safe rate
13 p(r) 97.69% Cut-off p as function of loan rate r
14
15
16
17 Probability density function f(pi) of pi
18 Beta distributed (standard) with
19 alpha 11.6900 1169
20 beta 3.2700 327
21 Density f(pi) 0.2409 PDF at cut-off p 1 pi * f(pi) (Alpha Cut-off p as
22 = 11.7; Beta = function of loan
0.9
23 Numerical integration of pi * f(pi) from 0 to cut-off p 3.3) rate r
0.8
24
25 n 10 Intervals for numerical integration 0.7
26 Lower bound 0 0.6
27 Upper bound (p) 97.69% Cut-off p
0.5
28 p * f(p) #VALUE!
29 E(πb,p(r)) 0.4
#VALUE! Expected profit bank @ p
30 E(πb,1) #VALUE! Profit w/o cut-off 0.3
31 E(πi,p) 0.22 Expected profit borrower @ p 0.2
32 0.1
33 0
34 0% 10% 20% 30% 40% 50% 6
35
36
6.0%S
Column Column S Profit 35.0% Colum P
37 nS m
maximizing
38 iz
loan rate 30.0%
39 5.0% lo
40 ra
41 25.0%
42 4.0%
43 20.0%
44 3.0%
45 Loan rate ®
15.0%
46
47 2.0%
48 10.0%
49
1.0%
50 5.0%
51
52 0.0% 0.0%
$0.5 $0.6 $0.7 $0.8 $0.9 $1.0 80% 9
Bank Expected Profit Cut-off pro
2.0%
10.0%

1.0%
5.0%

A 0.0%B C D E F G 0.0%
53 $0.5 $0.6 $0.7 $0.8 $0.9 $1.0 80% 9
54
Bank Expected Profit Cut-off pro
55
H I J K L M N O P
1 Back to Overview
dition, Wiley, p. 2122, Box 8.3
3
4
5
6
7
8
9
10 Data Tables for Charts
11
nvest W at safe 12rate δ Beta PDF f(pi) (Alpha = 11.7; Beta = 3.3)
13 pi * f(pi) (Alpha = 11.7; Beta = 3.3)
14
15 Support line cut-off
16 97.69% 0
17 97.69% #VALUE!
18
19 0.9769 #VALUE!
20 0 0 #VALUE!
21 Cut-off p as
pi * f(pi) (Alpha 0.03 0.03 #VALUE!
= 11.7; Beta 22 = function of loan 0.05 0.05 #VALUE!
3.3) 23 rate r 0.2 0.2 #VALUE!
24 0.4 0.4 #VALUE!
25 0.45 0.45 #VALUE!
26 0.5 0.5 #VALUE!
27 0.55 0.55 #VALUE!
28 0.6 0.6 #VALUE!
29 0.65 0.65 #VALUE!
30 0.7 0.7 #VALUE!
31 0.75 0.75 #VALUE!
32 0.8 0.8 #VALUE!
33 0.85 0.85 #VALUE!
10% 20% 34
30% 40% 50% 60% 70% 80% 90% 100% 0.88 0.88 #VALUE!
35 0.9 0.9 #VALUE!
36 0.93 0.93 #VALUE!
35.0% Colum Profit
37 nS maxim 0.95 0.95 #VALUE!
38 izing 0.98 0.98 #VALUE!
30.0%
39 loan 0.98 0.98 #VALUE!
40 rate 0.99 0.99 #VALUE!
25.0%
41 1 1 #VALUE!
42 1 1 #VALUE!
43
20.0%
44
45
15.0%
46
47
10.0%
48
49
505.0%
51
520.0%
80% 90% 100%
Cut-off probability
10.0%

5.0%

0.0% H I J K L M N O P
53 80% 90% 100%
54
55 Cut-off probability
Q R S T U V W X
1
2
3
4
5
6
7
8
9
10
11
(Alpha = 11.7; 12
Beta = 3.3)
= 11.7; Beta =133.3) max profit line Profit maximizing loan rate
14 0.00% #VALUE! 0 #VALUE! 0
15 #VALUE! #VALUE! 97.69% #VALUE! #VALUE!
16 #VALUE! #VALUE! 0.99 #VALUE! #VALUE!
17
18
19 97.69% #VALUE! #VALUE!
20 5% 97.69% #VALUE! #VALUE!
21 6% 97.69% #VALUE! #VALUE!
22 7% 97.69% #VALUE! #VALUE!
23 8% 97.69% #VALUE! #VALUE!
24 9% 97.69% #VALUE! #VALUE!
25 10% 97.69% #VALUE! #VALUE!
26 11% 97.69% #VALUE! #VALUE!
27 12% 97.69% #VALUE! #VALUE!
28 13% 97.69% #VALUE! #VALUE!
29 14% 97.69% #VALUE! #VALUE!
30 15% 97.69% #VALUE! #VALUE!
31 16% 97.69% #VALUE! #VALUE!
32 17% 97.69% #VALUE! #VALUE!
33 18% 97.69% #VALUE! #VALUE!
34 19% 97.69% #VALUE! #VALUE!
35 20% 97.69% #VALUE! #VALUE!
36 21% 97.69% #VALUE! #VALUE!
37 22% 97.69% #VALUE! #VALUE!
38 23% 97.69% #VALUE! #VALUE!
39 24% 97.69% #VALUE! #VALUE!
40 25% 97.69% #VALUE! #VALUE!
41 26% 97.69% #VALUE! #VALUE!
42 27% 97.69% #VALUE! #VALUE!
43 28% 97.69% #VALUE! #VALUE!
44 29% 97.69% #VALUE! #VALUE!
45 30% 97.69% #VALUE! #VALUE!
46
47
48
49
50
51
52
Q R S T U V W X
53
54
55
Formulas from Matthews & Thomson Book
Inspired by Matthews & Thompson (2008), 'The Economics of Banking', 2nd edition, Wiley, p. 122, Box 8.3
Stiglitz, J. E., & Weiss, A. (1981). Credit Rationing in Markets with Imperfect Information. The American Economic Review,
http://www.jstor.org/stable/1802787
Back to Overview
y, p. 122, Box 8.3
The American Economic Review, 71(3), 393-410.
Beta Distribution

X 0.6000
alpha 11.6900 1169
beta 3.2800 328
A 1
B 5
PDF (Standard: A=0, B=1)) 0.0000 #VALUE!
PDF 0.0000 #VALUE!
Cumulative (Standard: A=0, B=1)) 0 #VALUE!
Cumulative 0 #VALUE!

Standard beta distribution (A=0, B=1)

Alpha = 11.7; Beta = 3.3 Alpha = 11.7; Be


0 1
0 0.9
0 0.8
0 0.7
0 Alpha = 11.7;
Beta = 3.3 0.6
0 0.5
0 0.4
0 0.3 Alpha = 11.7;
0 0.2 Beta = 3.3
0 0.1
0 0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0 0.1 0.2 0.3 0.4 0.5

General beta distribution

Alpha = 11.7; Beta = 3.3 ;A=1 ;B=5 Alpha = 11.7; Beta =


0 0
0 Alpha = 11.7; Alpha = 11.7;
Beta = 3.3 0 Beta = 3.3
0 ;A=1 ;B=5 ;A=1 ;B=5
0
0
0
0
0
0
0 0
0 0
0 0
0 0
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 0.5 1 1.5 2 2.5 3
Back to Overview

Alpha = 11.7; Beta = 3.3

Alpha = 11.7; Beta = 3.3


1 0
0.9 0.03
0.8 0.05
0.7 0.1
0.15
0.6
0.2
0.5
0.25
0.4 0.3
0.3 Alpha = 11.7; 0.35
0.2 Beta = 3.3
0.4
0.1 0.45
0 0.5
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0.55
0.6
0.65
0.7
Alpha = 11.7; Beta = 3.3 ;A=1 ;B=5 0.75
0 0.8
Alpha = 11.7; 0.85
0 Beta = 3.3 0.9
0 ;A=1 ;B=5 0.95
0 0.98
1
0
0
0
0
0
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5
Alpha = 11.7; Beta = 3.3 Alpha = 11.7; Beta = 3.3 ;A=1 ;B=5

0 0.0000 0 0.0000
0 0 1 0 0
0 0 1.2 0 0
0 0 1.4 0 0
0 0 1.6 0 0
0 0 1.8 0 0
0 0 2 0 0
0 0 2.2 0 0
0 0 2.4 0 0
0 0 2.6 0 0
0 0 2.8 0 0
0 0 3 0 0
0 0 3.2 0 0
0 0 3.4 0 0
0 0 3.6 0 0
0 0 3.8 0 0
0 0 4 0 0
0 0 4.2 0 0
0 0 4.4 0 0
0 0 4.6 0 0
0 0 4.8 0 0
0 0 5 0 0
0 0
0 0
Formulas Beta Distribution

Formulas from http://wapedia.mobi/en/Beta_distribution retrieved 12/11/2008


The probability density function of the standard beta distribution (A=0, B=1)

Formulas from http://www.itl.nist.gov/div898/handbook/eda/section3/eda366h.htm


The probability density function of the beta distribution

The general formula for the probability density function of the beta distribution is

where p and q are the shape parameters, a and b are the lower and upper bounds, respectively, of the distribution, and B(p,q)

The case where a = 0 and b = 1 is called the standard beta distribution. The equation for the standard beta distribution is
Back to Overview

e distribution, and B(p,q) is the beta function. The beta function has the formula

rd beta distribution is