Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition

G. Di Nicolo, M. Lucchetta

Research output: Working paperDiscussion paperOther research output

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Abstract

We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages31
Volume2010-19S
Publication statusPublished - 2010

Publication series

NameEBC Discussion Paper
Volume2010-19S

Fingerprint

General equilibrium
Financial intermediation
Capitalization
Market power
General equilibrium modeling
Capital ratios
Pareto
General equilibrium model
Partial equilibrium
Financial policy
Bank risk
Bank capital
Systemic risk
Bank competition
Moral hazard
Rent
Perfect competition

Keywords

  • General Equilibrium
  • Bank Competition
  • Market Power Rents
  • Risk

Cite this

Di Nicolo, G., & Lucchetta, M. (2010). Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition. (EBC Discussion Paper; Vol. 2010-19S). Tilburg: EBC.
Di Nicolo, G. ; Lucchetta, M. / Financial Intermediation, Competition, and Risk : A General Equilibrium Exposition. Tilburg : EBC, 2010. (EBC Discussion Paper).
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abstract = "We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.",
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Di Nicolo, G & Lucchetta, M 2010 'Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition' EBC Discussion Paper, vol. 2010-19S, EBC, Tilburg.

Financial Intermediation, Competition, and Risk : A General Equilibrium Exposition. / Di Nicolo, G.; Lucchetta, M.

Tilburg : EBC, 2010. (EBC Discussion Paper; Vol. 2010-19S).

Research output: Working paperDiscussion paperOther research output

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T1 - Financial Intermediation, Competition, and Risk

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AU - Lucchetta, M.

N1 - This is also CentER Discussion Paper 2010-67S Pagination: 31

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N2 - We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.

AB - We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.

KW - General Equilibrium

KW - Bank Competition

KW - Market Power Rents

KW - Risk

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VL - 2010-19S

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PB - EBC

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Di Nicolo G, Lucchetta M. Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition. Tilburg: EBC. 2010. (EBC Discussion Paper).