THE BORROWER'S CURSE: OPTIMISM, FINANCE AND ENTREPRENEURSHIP

Paper number: 95/02

Year: 1995

Paper Category: Discussion Paper

Authors

David de Meza
Department of Economics, University of Exeter.

Clive Southey
Department of Economics, University of Guelph.

Abstract

This paper argues that most of the facts charaterising small-scale businesses, including high failure rates, reliance on bank credit rather than equity finance, relatively low interest rate margins, and credit rationing, can be explained by a tendancy for those who are excessively optimistic to dominate new entrants. Drawing on findings in psycology, we model entrants as relatively naive optimisers. Banks on the other hand are viewed as well informed and efficient processors of information.

JEL Classification numbers: D82

* We would like to thank seminar participants at Bristol, Guelph, Swansea, and Warwick and Karim Abadir, Tony Brewer, Jane Black, Mark Blaug, Bob Gould, Qi Li, Ben Lockwood, and Gareth Myles for their useful comments.