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Risk and Intermediation in a Dual Financial Market Model

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  • Reichlin, Pietro
  • Bloise, Gaetano

Abstract

This Paper investigates the relationship between risk and productive activity and the degree of financial intermediation in a model with moral hazard. Entreprenuers can simultaneously get credit from two types of competing institutions: ?financial intermediaries? and ?local lenders?. The former are competitive firms with a comparative advantage in diversifying credit risks, and the latter have superior information about the investment returns of a ?nearby? entrepreneur. This information advantage allows local lenders to save on intermediation costs that are otherwise related to lending activity. By diversifying risks, financial intermediaries are able to offer a safe asset to local lenders and, because of intermediation costs, the latter are willing to diversify their portfolio by offering some direct lending to the nearby entrepreneur (incomplete insurance). 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.

Suggested Citation

  • Reichlin, Pietro & Bloise, Gaetano, 2001. "Risk and Intermediation in a Dual Financial Market Model," CEPR Discussion Papers 2909, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2909
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    References listed on IDEAS

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    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. 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.
    3. 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.
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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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