Optimal Return in a Model of Bank Small-business Financing

Oana Peia 1, 2 Radu Vranceanu 3
3 ESSEC Business School and THEMA (UMR 8184)
THEMA - Théorie économique, modélisation et applications, Economics Department
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.
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Oana Peia, Radu Vranceanu. Optimal Return in a Model of Bank Small-business Financing. 2014. ⟨hal-00952641⟩

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