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Optimal Return in a Model of Bank Small-business Financing

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  • Oana Peia

    (ESSEC Business School - ESSEC Business School, THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)

  • Radu Vranceanu

    ()
    (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise, Economics Department - 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 HAL in its series Post-Print with number hal-00952641.

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Date of creation: 13 Feb 2014
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Handle: RePEc:hal:journl:hal-00952641

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Related research

Keywords: Bank finance ; small business ; global games ; switching equilibrium ; optimal return rium; optimal return;

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