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Coarse Information and Entrepreneurial Risk Choice

Author

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  • Pierre-Yves Yanni

    (UQAM)

Abstract

I analyze a model of anonymous credit markets with adverse selection and moral hazard in which investors finance entrepreneurs and only observe whether they have defaulted in the past. There is a dynamic complementarity in risk choice: incentives to choose the safe project over the risky project in the current period are stronger if other entrepreneurs ran safe projects in the past and if they are expected to run safe projects in the future. This results in multiple equilibria that depend on agents' expectations but also on history. I show that reputation concerns can induce entrepreneurs to be too conservative. In this case the economy converges to an inefficient equilibrium in which entrepreneurs choose safe projects over risky ones despite their lower return. A transition to the socially optimal risky equilibrium can be implemented in a way that balances the budget and is Pareto improving.

Suggested Citation

  • Pierre-Yves Yanni, 2012. "Coarse Information and Entrepreneurial Risk Choice," 2012 Meeting Papers 1142, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:1142
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    References listed on IDEAS

    as
    1. Jeffrey Ely & Drew Fudenberg & David K. Levine, 2008. "When is reputation bad?," World Scientific Book Chapters, in: Drew Fudenberg & David K Levine (ed.), A Long-Run Collaboration On Long-Run Games, chapter 10, pages 177-205, World Scientific Publishing Co. Pte. Ltd..
    2. Jeffrey C. Ely & Juuso Välimäki, 2003. "Bad Reputation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(3), pages 785-814.
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