Bar-Isaac, Heski and Cuñat, Alejandro (2005) Long-term debt and hidden borrowing. Discussion paper, 542. Financial Markets Group, London School of Economics and Political Science, London, UK.
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We consider borrowers with the opportunity to raise funds from a competitive banking sector that shares information, and from an alternative hidden lender. The presence of the hidden lender restricts the contracts that can be obtained from the banking sector. In equilibrium some borrowers obtain funds from both the banking sector and the inefficient hidden lender simultaneously. We further show that as the cost of borrowing from the hidden lender increases, total welfare increases. We generalize the model to allow for a partially hidden lender and obtain qualitatively similar results.
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