A Smoke Screen Theory of Financial Intermediation
University of Orleans
July 15, 2007
Paris December 2008 Finance International Meeting AFFI - EUROFIDAI
This paper explores the role of diversification and size in protecting information. We present a simple two period credit market with a sophisticated lender faced with competitors who free ride on his screening activity. Absent commitment problems, the lender funds one borrower and exerts optimal evaluation. When borrowers cannot commit to a long term relationship, the free riding problem is responsible for too little evaluation. We show how this problem can be mitigated by simultaneously financing several borrowers. This effect provides a rationale for intermediaries as an 'information garbling' device.
Number of Pages in PDF File: 31
Keywords: financial intermediation, informational rent, asymmetric information, free riding, diversificationworking papers series
Date posted: October 13, 2008
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