Intermediation Via Credit Chains

61 Pages Posted: 11 Jan 2022 Last revised: 19 Dec 2024

See all articles by Zhiguo He

Zhiguo He

Stanford University - Knight Management Center

Jian Li

Columbia University - Columbia Business School, Finance

Multiple version iconThere are 2 versions of this paper

Date Written: January 2022

Abstract

The modern financial system features complicated financial intermediation chains, with each layer performing a certain degree of credit/maturity transformation. We develop a dynamic model in which an entrepreneur borrows from overlapping-generation households via layers of funds, forming a credit chain. Each intermediary fund in the chain faces rollover risks from its lenders, and the optimal debt contracts among layers are time invariant and layer independent. The model delivers new insights regarding the benefits of intermediation via layers: the chain structure insulates interim negative fundamental shocks and protects the underlying cash flows from being discounted heavily during bad times, resulting in a greater borrowing capacity. We show that the equilibrium chain length minimizes the run risk for any given contract and find that restricting credit chain length can improve total welfare once the available funding from households has been endogenized.

Suggested Citation

He, Zhiguo and Li, Jian, Intermediation Via Credit Chains (January 2022). NBER Working Paper No. w29632, Available at SSRN: https://ssrn.com/abstract=4004845

Zhiguo He (Contact Author)

Stanford University - Knight Management Center ( email )

655 Knight Way
Stanford, CA 94305-7298
United States

Jian Li

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

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