European Business Schools Librarian's Group
ESSEC Working Papers,
ESSEC Research Center, ESSEC Business School
No WP1403: Optimal Return in a Model of Bank Small-business Financing
Oana Peia () and Radu Vranceanu ()
Additional contact information
Oana Peia: ESSEC Business School, Postal: 1 AVENUE BERNARD HIRSCH, CS 50105 CERGY, 95021 CERGY PONTOISE CEDEX
Radu Vranceanu: ESSEC Business School, Postal: 1 AVENUE BERNARD HIRSCH, CS 50105 CERGY, 95021 CERGY PONTOISE CEDEX
Abstract: This paper develops a simple model showing how banks can increase the access to finance of small, risky firms by mitigating coordination problems among investors. If investors observe a biased signal about the true implementation cost of real sector projects, the model can be solved for a switching equilibrium in the classical global games approach. We show that the socially optimal interest rate that maximizes the probability of success of the firm is higher than the risk-free rate. Yet if banks maximize investors' expected return, they would choose an interest higher than the socially optimal one. This gives rise to a form of credit rationing, which stems from the funding constraints of the banks.
Keywords: Bank finance; Small business; Global games; Switching equilibrium; Optimal return rium; Optimal return
23 pages, February 2014
Full text files
WP1403.pdf
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