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Optimal Return in a Model of Bank Small-business Financing

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  • Peia, Oana

    ()
    (ESSEC Business School)

  • Vranceanu , Radu

    ()
    (ESSEC Business School)

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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Bibliographic Info

Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number WP1403.

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Length: 23 pages
Date of creation: Feb 2014
Date of revision:
Handle: RePEc:ebg:essewp:dr-14003

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Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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Web page: http://www.essec.edu/
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Related research

Keywords: Bank finance; Small business; Global games; Switching equilibrium; Optimal return rium; Optimal return;

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References

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