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Risk and intermediation in a dual financial market model

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  • BLOISE, Gaetano
  • REICHLIN, Pietro

Abstract

This paper investigates the relation between risk and the degree of financial intermediation in a model with moral hazard. Entrepreneurs can simultaneously get credit from two type of competing institutions:"financial intermediairies" and "local lenders". The former are competitive firms issuing deposits and having a comparative advantage in diversifying credit risks. The latter are individuals with a comparative advantage in credit arrangements with a "nearby" entrepreneur. Because of intermediation costs, local lenders are willing to diversify their portfolio by offering some direct lending to nearby entrepreneurs.We show that, in some cases, a fall in intermediation costs, by inducing local lenders to choose a safer portfolio reduces entrepreneurs' effort and increases the probability of default. In these cases a taxation policy may be welfare-improving.

Suggested Citation

  • BLOISE, Gaetano & REICHLIN, Pietro, 2002. "Risk and intermediation in a dual financial market model," LIDAM Discussion Papers CORE 2002004, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:2002004
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    References listed on IDEAS

    as
    1. Ross Levine, 1997. "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature, American Economic Association, vol. 35(2), pages 688-726, June.
    2. Timothy Besley, 1995. "Nonmarket Institutions for Credit and Risk Sharing in Low-Income Countries," Journal of Economic Perspectives, American Economic Association, vol. 9(3), pages 115-127, Summer.
    3. Arnott, Richard & Stiglitz, Joseph E, 1991. "Moral Hazard and Nonmarket Institutions: Dysfunctional Crowding Out or Peer Monitoring?," American Economic Review, American Economic Association, vol. 81(1), pages 179-190, March.
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    More about this item

    Keywords

    financial intermediation; moral hazard;

    JEL classification:

    • A10 - General Economics and Teaching - - General Economics - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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