Intro to Econ: Ninth Lecture Aside – The Winner’s Curse

For one last time, I want to come back to the problem of whether you get a loan for your project under the assumption that the risk inherent in your project is stochastically independent of other investment risks. So this was our problem (see also here and here):

 \begin{tabular}{c|ccccc} Scenario & Income & Probability & you get & investor gets \\ \hline good & 200.000 & 80\% & 200.000-x & x \\ bad & -50.000 & 20\% & 0 & -50.000 \\ \end{tabular},

 

where  x is the repayment amount that you pay back to the investor in case of the project being successful. We argued (in a previous post) that the range of feasible interest rates is 12,5% to 200%. Anything outside that will certainly not be accepted by either the investor or by you.

Suppose that you and the investor are close to agreeing to an interest rate of just over 12,5%. Put yourself in the shoes of the investor for a moment. What might worry you in this case?

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