代写ECON701 2016 Applied Microeconomics

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    • 代写ECON701 2016 Applied Microeconomics
    ECON701
    2016
    Applied Microeconomics
    Assignment 2
    Due: 4pm, Friday, 7 October
    1. Adverse selection in the market for venture capital.1
    Consider a competitive venture capital market with 1000 entrepreneurs
    seeking …nance for projects –the demand side –and 800 venture capi-
    talists with cash to lend –the supply side. The market forces of demand
    and supply determine the interest rate, r, on loans.
    Each entrepreneur has $C in collateral and needs to borrow $B to get
    her project o¤the ground. Each project will either “succeed”and make
    a positive return or “fail”and make nothing. There are two types of
    project: “high risk-high return”projects which succeed with probabil-
    ity 1
    4 and return $6400 if successful, and “low risk-low return”projects
    which succeed with probability 1
    2 and return $3200 if successful. (Note
    that each type of project has an expected return of $1600.) Half of
    the entrepreneurs (i.e., 500) have “high risk-high return”projects and
    the other half have “low risk-low return”projects. Each entrepreneur
    knows the type of her own project. Venture capitalists, however, can-
    not observe the type of project for which an entrepreneur seeks funding
    (though they know that there are 500 projects of each type in total).
    If an entrepreneur borrows $B, she must pay back (1 + r)B if her
    project succeeds and must forfeit her collateral if it fails. Entrepreneurs
    are risk neutral and will borrow if, and only if, they can make a non-
    negative expected pro…t. That is, an entrepreneur with a “high risk-high
    return”project will borrow if, and only if,
    
    1
    4
    
    [6400