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Risk pooling, intermediation efficiency, and the business cycle

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  • Dindo, Pietro
  • Modena, Andrea
  • Pelizzon, Loriana

Abstract

We develop a tractable macro-finance model in which entrepreneurs cannot pool idiosyncratic risks across firms due to restricted market participation. Costly risk pooling is provided by financial intermediaries who also issue safe assets via balance sheet leverage. We characterize the general equilibrium effects that associate intermediation costs with the dynamics of output and show that higher (lower) cost efficiency fosters (weakens) growth but also amplifies (dampens) its fluctuations. The model predicts negative relationships between the financial sector’s costs-to-assets and leverage ratios and the business cycle, which we find to hold for the US economy.

Suggested Citation

  • Dindo, Pietro & Modena, Andrea & Pelizzon, Loriana, 2022. "Risk pooling, intermediation efficiency, and the business cycle," Journal of Economic Dynamics and Control, Elsevier, vol. 144(C).
    • Handle: RePEc:eee:dyncon:v:144:y:2022:i:c:s0165188922002044
    DOI: 10.1016/j.jedc.2022.104500
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    More about this item

    Keywords

    Amplification; Business cycle; Efficiency; Dampening; Restricted market participation; Risk pooling;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E69 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Other
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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