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Risk and intermediation in a dual financial market model

Author

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  • BLOISE, Gaetano
  • REICHLIN, Pietro

Abstract

This paper investigates the relation between risk and the degree of financial intermediation in a model with moral hazard. Entrepreneurs can simultaneously get credit from two type of competing institutions:"financial intermediairies" and "local lenders". The former are competitive firms issuing deposits and having a comparative advantage in diversifying credit risks. The latter are individuals with a comparative advantage in credit arrangements with a "nearby" entrepreneur. Because of intermediation costs, local lenders are willing to diversify their portfolio by offering some direct lending to nearby entrepreneurs.We show that, in some cases, a fall in intermediation costs, by inducing local lenders to choose a safer portfolio reduces entrepreneurs' effort and increases the probability of default. In these cases a taxation policy may be welfare-improving.

Suggested Citation

  • BLOISE, Gaetano & REICHLIN, Pietro, 2002. "Risk and intermediation in a dual financial market model," LIDAM Discussion Papers CORE 2002004, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:2002004
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    JEL classification:

    • A10 - General Economics and Teaching - - General Economics - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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