Opacity: Insurance and Fragility

39 Pages Posted: 16 Dec 2019 Last revised: 23 Dec 2019

Multiple version iconThere are 2 versions of this paper

Date Written: December 4, 2019

Abstract

What are the effects of banks holding opaque, complex assets? Should regulators require bank assets to be more transparent? I study these questions in a model of financial intermediation where opacity determines how long the realized value of an asset remains unknown. By allowing a bank to sell assets before the realization is known, opacity provides insurance to the bank's depositors. However, higher opacity also increases depositors' incentives to join a bank run. In choosing the level of opacity, therefore, a bank faces a trade-off between providing insurance and increasing fragility. If depositors can accurately observe the level of opacity, banks will choose the socially-efficient level. If depositors are unable to observe this choice, however, banks will have an incentive to become overly opaque and regulation to limit opacity can improve welfare.

Keywords: Bank runs, Financial fragility, Opacity

JEL Classification: G21,G28

Suggested Citation

Izumi, Ryuichiro, Opacity: Insurance and Fragility (December 4, 2019). Available at SSRN: https://ssrn.com/abstract=3495686 or http://dx.doi.org/10.2139/ssrn.3495686

Ryuichiro Izumi (Contact Author)

Wesleyan University ( email )

Middletown, CT 06459
United States

HOME PAGE: http://www.ryuichiroizumi.com

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