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Capital immobility and the reach for yield

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  • Moreira, Alan

Abstract

I build a model in which financial intermediation slows down capital flows. Investors optimally learn from intermediary performance to allocate capital toward profitable intermediaries. Intermediaries reach for yield—i.e., they invest in high-tail-risk assets—in an attempt to drive flows and reduce liquidation risk. Intermediaries with strong opportunities face a trade-off between choosing a portfolio that maximizes profitability, and choosing one that maximizes the speed at which capital flows. In equilibrium, reaching for yield is stronger among intermediaries with weak opportunities, resulting in a reduction in the informativeness of performance; investors thus take longer to learn, and capital flows become less responsive to performance. Capital becomes slow-moving because the reach for yield dampens learning. The model predicts capital immobility to be stronger when tail risk is high; when tail risk is under priced; and in asset classes with large cross-sectional variation in tail-risk exposures.

Suggested Citation

  • Moreira, Alan, 2019. "Capital immobility and the reach for yield," Journal of Economic Theory, Elsevier, vol. 183(C), pages 907-951.
  • Handle: RePEc:eee:jetheo:v:183:y:2019:i:c:p:907-951
    DOI: 10.1016/j.jet.2019.07.010
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    More about this item

    Keywords

    Slow-moving capital; Limit-to-arbitrage; Financial intermediation; Reputation concerns;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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