Unbundling financial imperfections

Lending frictions vs. trading frictions

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Two essential imperfections determine the degree of the financial sector development in an economy: lending frictions, which constrain the ability to extend loans to borrowers; and, trading frictions, which constrain the trading of these loans in secondary markets. I develop a dynamic general equilibrium model where long-term investment is the engine of growth to study macroeconomic consequences of financial development. In the model, long-term loans are extended to entrepreneurs in a primary market and then traded in a secondary market among financiers. In competitive equilibria, reductions in either lending or trading frictions enlarge the financial sector. Although financial deepening through low-cost lending is always welfare improving, financial deepening stimulated by low-cost trading could be detrimental to the society. I illustrate that a model qualitatively consistent with the U.S. financial development episode of the last 30 years should exhibit disproportionately large reductions in trading frictions relative to lending frictions.
Original languageEnglish
Pages (from-to)1401-1441
JournalMacroeconomic Dynamics
Volume23
Issue number4
DOIs
Publication statusPublished - Jun 2019

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Friction
Lending
Unbundling
Imperfections
Loans
Financial deepening
Secondary market
Financial development
Competitive equilibrium
Entrepreneurs
Trading costs
Macroeconomics
Dynamic general equilibrium model
Financial sector
Financial sector development
Costs

Keywords

  • long-term investment
  • secondary markets
  • financial frictions

Cite this

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title = "Unbundling financial imperfections: Lending frictions vs. trading frictions",
abstract = "Two essential imperfections determine the degree of the financial sector development in an economy: lending frictions, which constrain the ability to extend loans to borrowers; and, trading frictions, which constrain the trading of these loans in secondary markets. I develop a dynamic general equilibrium model where long-term investment is the engine of growth to study macroeconomic consequences of financial development. In the model, long-term loans are extended to entrepreneurs in a primary market and then traded in a secondary market among financiers. In competitive equilibria, reductions in either lending or trading frictions enlarge the financial sector. Although financial deepening through low-cost lending is always welfare improving, financial deepening stimulated by low-cost trading could be detrimental to the society. I illustrate that a model qualitatively consistent with the U.S. financial development episode of the last 30 years should exhibit disproportionately large reductions in trading frictions relative to lending frictions.",
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Unbundling financial imperfections : Lending frictions vs. trading frictions. / Uras, Burak.

In: Macroeconomic Dynamics, Vol. 23, No. 4, 06.2019, p. 1401-1441.

Research output: Contribution to journalArticleScientificpeer-review

TY - JOUR

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PY - 2019/6

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AB - Two essential imperfections determine the degree of the financial sector development in an economy: lending frictions, which constrain the ability to extend loans to borrowers; and, trading frictions, which constrain the trading of these loans in secondary markets. I develop a dynamic general equilibrium model where long-term investment is the engine of growth to study macroeconomic consequences of financial development. In the model, long-term loans are extended to entrepreneurs in a primary market and then traded in a secondary market among financiers. In competitive equilibria, reductions in either lending or trading frictions enlarge the financial sector. Although financial deepening through low-cost lending is always welfare improving, financial deepening stimulated by low-cost trading could be detrimental to the society. I illustrate that a model qualitatively consistent with the U.S. financial development episode of the last 30 years should exhibit disproportionately large reductions in trading frictions relative to lending frictions.

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