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How Do Banks Pick Safer Ventures?  A Theory Relating the Importance of Risk Aversion and Collateral to Interest Margins and Credit Rationing

How Do Banks Pick Safer Ventures? A Theory Relating the Importance of Risk Aversion and Collateral to Interest Margins and Credit Rationing

The paper augments the asymmetric information literature on bank lending to new ventures by focusing on the more neglected area of moral hazard; specifically the relationship between risk aversion, an entrepreneur?s wealth and the provision of collateral. The results highlight some interesting nuances which are not characteristic of the properties of models that have dominated the literature and which mainly focus on the problems of adverse selection. Contrary to models such as Evans and Jovanovic (1989) Blanchflower and Oswald (1998) our model shows that credit rationing does not necessarily have to be negatively related to an entrepreneur?s initial wealth. Our model shows that banks can use collateral as a means of affecting an entrepreneur?s risk aversion – the tactic being least... Show More
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