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Intermediation and vertical integration

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  • Mitchell Berlin
  • Loretta J. Mester

Abstract

This paper views financial intermediaries as vertically integrated firms. The authors explore how competitive conditions in retail and wholesale funding markets affect the incentive for (upstream) originators and (downstream) fund managers to integrate. The underlying tradeoff in our model is driven by the choice between the production of an illiquid but high yielding loan and a liquid but relatively low yielding bond. The authors find that greater homogeneity among savers has two effects, both of which tend to increase the incentive to form integrated intermediaries. Greater homogeneity both increases competition between independent fund managers and reduces the likelihood of inefficient underinvestment by integrated intermediaries. The authors also find that the incentive to integrate is greater when fund managers have more power in the market for firms' securities.
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Suggested Citation

  • Mitchell Berlin & Loretta J. Mester, 1998. "Intermediation and vertical integration," Proceedings, Federal Reserve Bank of Cleveland, issue Aug, pages 500-523.
    • Handle: RePEc:fip:fedcpr:y:1998:i:aug:p:500-523
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    Cited by:

    1. Mokhtar Kouki & Sang Park & Eric Renault, 2014. "Estimating scale economies in financial intermediation: a doubly indirect inference," Journal of Productivity Analysis, Springer, vol. 41(3), pages 351-365, June.

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