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Stochastic Dynamic Modeling - An Aid to Agricultural Lender Decision Making



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Stochastic Dynamic Modeling An Aid to Agricultural Lender Decision Making Cole R Gustafson Factors affecting a lender s decision to grant farmers operating credit in North Dakota are quantified in an intertemporal loan profitability model using stochastic dynamic programming Experimental data obtained from a panel of lenders demonstrates the sensitivity of an optimal policy to changes in a lender s discount rate a borrower s repayment status and patronage The value of credit scoring models that appraise a borrower s credit worthiness also is determined Key words credit credit scoring dynamic programming experiment simulation An apparent paradox exists in agricultural credit Despite high levels of default and negative rates of return lenders continue to grant operating credit to established farmers with whom they have no prior business experience In North Dakota 6 9 of all farmers change financial institutions annually Leistritz et al A discontinued line of credit is not the sole reason farmers change lenders Credit worthy farmers may shift lenders to obtain more favorable terms expanded financial services and increased security 1 Lenders have difficulty appraising the repayment potential of prospective borrowers because available financial records are often incomplete nonstandard based on accounting rather than economic principles and fail to incorporate the operator s managerial and entrepreneurial abilities Fisher and McGowan Due to this informational asymmetry lenders only obtain true knowledge of the borrower s operation through trial and experience Traditional loan profitability analyses are Cole R Gustafson is an assistant professor of agricultural economics North Dakota State University North Dakota Experiment Station Paper No 1713 The author would like to thank Peter J Barry C Robert Taylor three anonymous reviewers and colleagues at North Dakota State University for their useful comments and Dale Beyer who assisted with administration of the study s



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