Banking (Conservatively) with Optimists

Michael Manove and A. Jorge Padilla

RAND Journal of Economics, 1999, vol. 30, issue 2, 324-350

Abstract: Commercial banks frequently encounter optimistic entrepreneurs whose perceptions are biased by wishful thinking. Bankers are left with a difficult screening problem: separating realistic entrepreneurs from optimists who may be clever, knowledgeable, and completely sincere. We build a game-theoretic model of the screening process. We show that although entrepreneurs may practice self-restraint to signal realism, competition may lead banks to be insufficiently conservative in their lending, thus reducing capital-market efficiency. High collateral requirements decrease efficiency further. We discuss bank regulation and bankruptcy rules in connection with the problems that optimistic entrepreneurs present.

Date: 1999
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Related works:
Working Paper: Banking (Conservatively) With Optimists (1998)
Working Paper: Banking (conservatively) with Optimists (1997)
Working Paper: Banking (Conservatively) with Optimists (1997)
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