A Dilution Cost Approach to Financial Intermediation and Securities Markets
AbstractThis paper proposes a model of financial markets and corporate finance, with asymmetric information and no taxes, where equity issues, Back debt and Bond financing may all co-exist in equilibrium. The paper emphasizes the relationship Banking aspect of financial intermediation: firms turn to banks as a source of investment mainly because banks are good at helping them through times of financial distress. The debt restructuring service that banks may offer, however, is costly. Therefore, the firms which do not expect to be financially distressed prefer to obtain a cheaper market source of funding through bank or equity issues. This explains why bank lending and bond financial may co-exist in equilibrium. The reason why firms or banks also issue equity in our model is simply to avoid bankruptcy. Banks have the additional motive that they need to satisfy minimum capital adequacy requirements. Several types of equilibria are possible, one of which has all the main characteristics of a Â¶credit crunchÂ¶. This multiplicity implies that the channels of monetary policy may depend on the type of equilibrium that prevails, leading sometimes to support a Â¶credit viewÂ¶ and other time the classical Â¶money viewÂ¶.
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Bibliographic InfoPaper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 1998-40.
Date of creation: 1998
Date of revision:
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Web page: http://center.uvt.nl
Other versions of this item:
- Xavier Freixas & Patrick Bolton, 1998. "A Dilution Cost Approach to Financial Intermediation and Securities Markets," FMG Discussion Papers dp305, Financial Markets Group.
- Patrick Bolton & Xavier Freixas, 1997. "A dilution cost approach to financial intermediation and securities markets," Economics Working Papers 286, Department of Economics and Business, Universitat Pompeu Fabra.
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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