Most informal finance comes from family and friends. Existing informal finance theories cannot match two characteristics of family finance: family investors may accept below-market or even negative returns, yet borrowers often prefer formal finance. We argue that social preferences make family finance cheap but create shadow costs that nonetheless discourage its use: Committing family funds to risky investment displaces intrafamily insurance and undermines limited liability. The same characteristics that sustain familial insurance thus render family finance a poor source of risk capital. Even when overcoming capital constraints requires social ties, intermediation and semiformalization may therefore be crucial for promoting risk taking.
Received April 29, 2013; accepted December 4, 2015 by Editor Andrew Karolyi.
Keywords: G32; G21; O16; O17; D19; D64
Journal Article. 19816 words. Illustrated.
Subjects: Corporate Governance ; Banking ; Economic Development ; Household Behaviour and Family Economics ; Welfare Economics
Full text: subscription required