A Model of Financial Structure and Financial Fragility

34 Pages Posted: 8 Jun 2002

See all articles by Robert Van Order

Robert Van Order

Federal Home Loan Mortgage Corporation (FHLMC) - Housing Economics and Financial Research

Date Written: April 2002

Abstract

This paper presents an asymmetric information model of financial structure. The model has two types of financial institutions: banks (traditional intermediaries) and securities markets, both of which can hold loans made to firms to finance investments. The securities markets raise money at lower cost, but they suffer a lemons problem because the banks have local information, which can be used to select against them. The result is an equilibrium that can exhibit fragility in the sense that small parameter changes, such as changes in the cost advantage of the securities market or the risk structure of loans, can lead to discontinuous changes in interest rates and asset prices that cannot be explained by changes in fundamentals (e.g., changes in risks or in returns on the projects) and to changes in market structure that have properties that look like contagion and panics.

Keywords: Financial structure, financial fragility

JEL Classification: E44, F30, G10

Suggested Citation

Van Order, Robert, A Model of Financial Structure and Financial Fragility (April 2002). Available at SSRN: https://ssrn.com/abstract=312664 or http://dx.doi.org/10.2139/ssrn.312664

Robert Van Order (Contact Author)

Federal Home Loan Mortgage Corporation (FHLMC) - Housing Economics and Financial Research ( email )

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