Abstract

Entrepreneurs who seek financing for projects typically do so in decentralized markets where they need to approach investors sequentially. We study how well such sequential markets allocate resources when investors have expertise in evaluating investment opportunities, and how surplus is split between entrepreneurs and financiers. Contrary to common belief, we show that the introduction of a credit registry that tracks the application history of a borrower leads to more adverse selection, quicker market break down, and higher rents to investors which are not competed away even as the number of investors grows large. Although sequential search markets lead to substantial investment inefficiencies, they can nevertheless be more efficient than a centralized exchange where excessive competition may impede information aggregation. We also show that investors who rely purely on public information in their lending decisions can out-compete better informed investors with soft information, and that an introduction of interest rate caps can increase the efficiency of the market.