Coarse Information and Entrepreneurial Risk Choice

Pierre-Yves Yanni
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Pierre-Yves Yanni: UQAM

No 1142, 2012 Meeting Papers from Society for Economic Dynamics

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.

Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed012:1142

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