Capital immobility and the reach for yield

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.