Optimal banking with delegated monitoring
Year: 2024
Type: article
Abstract: We propose a model of financial intermediation based on delegated monitoring, where firms' returns are private information that lenders can ascertain through costly state verification. Our model has two key features: lenders cannot commit to their verification strategies and there are aggregate shocks. Simple debt contracts are Pareto optimal with or without intermediation. We show that the benefits of intermediation can be limited by financial instability in the presence of aggregate shocks. However, a well-designed resolution mechanism ensures the Pareto optimality of financial intermediation, and a bail-out policy can restore financial stability.
Source: Journal of Economic Theory
Authors: Nemanja Antic, Tai-Wei Hu
Institutions: Northwestern University, University of Bristol
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: hybrid
Estimated APC paid: $2,810
OpenAlex ID: W4402128603