Optimal Return in a Model of Bank Small-business Financing

Oana Peia and Radu Vranceanu

No WP1403, ESSEC Working Papers from ESSEC Research Center, 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.

Keywords: Bank finance; Small business; Global games; Switching equilibrium; Optimal return rium; Optimal return (search for similar items in EconPapers)
JEL-codes: C72 D82 G21 G32 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2014-02
New Economics Papers: this item is included in nep-ban and nep-ppm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Optimal Return in a Model of Bank Small-business Financing (2014)
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