Entrepreneurial Risk Choice And Credit Market Equilibria

The authors analyze under what conditions credit markets are efficient in providing loans to entrepreneurs who can start a new project after previous failure. An entrepreneur of uncertain talent chooses the riskiness of her project. If banks cannot perfectly observe the risk of previous projects, two equilibria may coexist: an inefficient equilibrium in which the entrepreneur undertakes a low-risk project and has no access to finance after failure; and a more efficient equilibrium in which the entrepreneur undertakes high-risk projects and gets financed even after an endogenously determined number of failures.