A Model of Financial Structure and Financial Fragility
34 Pages Posted: 8 Jun 2002
Date Written: April 2002
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: Suggested Citation