IDEAS home Printed from https://ideas.repec.org/p/cns/cnscwp/201008.html
   My bibliography  Save this paper

Relationship Finance, Market Finance and Endogenous Business Cycles

Author

Listed:
  • LG Deidda
  • B. Fattouh

Abstract

This paper develops an overlapping generation model with asymmetric information in the credit market such that the interplay between relationship finance supplied by investors who monitor investment decisions ex-ante and market finance supplied by investors who relay on public information can be the source of endogenous business fluctuations. Monitoring helps reducing the inefficiency caused by moral hazard. However, the incentives of entrepreneurs to demand relationship finance to induce monitoring –which is also non-contractible – are weaker the lower is the return to investment. If the return to investment is low enough, entrepreneurs demand too little relationship finance. This leads to an inefficiently low level of monitoring and of entrepreneurial effort. Under decreasing marginal returns to capital, the model generates a reversion mechanism that can induce macroeconomic instability. The economy can experience endogenous business cycles characterized by a pro-cyclical behavior of the relative importance of relationship finance. This is consistent with the pro-cyclical behavior of the indicator of relative importance of relationship finance, which we construct based on quarterly and annual data from the US Flow of Funds Accounts for the non-financial corporate business sector.

Suggested Citation

  • LG Deidda & B. Fattouh, 2010. "Relationship Finance, Market Finance and Endogenous Business Cycles," Working Paper CRENoS 201008, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
  • Handle: RePEc:cns:cnscwp:201008
    as

    Download full text from publisher

    File URL: https://crenos.unica.it/crenos/node/2704
    Download Restriction: no

    File URL: https://crenos.unica.it/crenos/sites/default/files/WP10-08.pdf
    Download Restriction: no
    ---><---

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. OA Carboni, 2010. "Heterogeneity in R&D Cooperation: An Empirical Investigation," Working Paper CRENoS 201029, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.

    More about this item

    Keywords

    moral hazard; endogenous business cycles; relationship finance; market finance; monitoring;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cns:cnscwp:201008. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CRENoS (email available below). General contact details of provider: https://edirc.repec.org/data/crenoit.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.