Intermediation via Credit Chains

Zhiguo He () and Jian Li

No 29632, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The modern financial system features complicated financial intermediation chains, with each layer performing a certain degree of credit/maturity transformation. We develop a dynamic model in which an entrepreneur borrows from overlapping-generation households via layers of funds, forming a credit chain. Each intermediary fund in the chain faces rollover risks from its lenders, and the optimal debt contracts among layers are time invariant and layer independent. The model delivers new insights regarding the benefits of intermediation via layers: the chain structure insulates interim negative fundamental shocks and protects the underlying cash flows from being discounted heavily during bad times, resulting in a greater borrowing capacity. We show that the equilibrium chain length minimizes the run risk for any given contract and find that restricting credit chain length can improve total welfare once the available funding from households has been endogenized.

JEL-codes: D85 E44 E51 G21 G23 G33 (search for similar items in EconPapers)
Date: 2022-01
New Economics Papers: this item is included in nep-ban, nep-dge, nep-fdg, nep-mac and nep-rmg
Note: AP CF EFG IO
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