Intermediation and Voluntary Exposure to Counterparty Risk

Maryam Farboodi

No 29467, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: I study a model of the financial sector in which intermediation among debt financed banks gives rise to an endogenous core-periphery network – few highly interconnected and many sparsely connected banks. Endogenous intermediation generates excessive systemic risk in the financial network. Financial institutions have incentives to capture intermediation spreads through strategic borrowing and lending decisions. By doing so, they tilt the division of surplus along an intermediation chain in their favor, while at the same time reducing aggregate surplus. The network is inefficient relative to a constrained efficient benchmark since banks who make risky investments “overconnect”, exposing themselves to excessive counterparty risk, while banks who mainly provide funding end up with too few connections.

JEL-codes: D85 G20 G21 (search for similar items in EconPapers)
Date: 2021-11
New Economics Papers: this item is included in nep-ban, nep-fdg and nep-net
Note: CF
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Citations: View citations in EconPapers (6)

Published as Maryam Farboodi, 2023. "Intermediation and Voluntary Exposure to Counterparty Risk," Journal of Political Economy, vol 131(12), pages 3267-3309.

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