Foreseen risks

João F. Gomes, Marco Grotteria and Jessica A. Wachter

Journal of Economic Theory, 2023, vol. 212, issue C

Abstract: Large crises tend to follow rapid credit expansions. Causality, however, is far from obvious. We show how this pattern arises naturally when financial intermediaries optimally exploit economic rents that drive their franchise value. As this franchise value fluctuates over the business cycle, so too do the incentives to engage in risky lending. The model leads to novel insights on the effects of unconventional monetary policies in developed economies. We argue that bank lending might have responded less than expected to these interventions because they enhanced franchise value, inadvertently encouraging banks to pursue safer investments in low-risk government securities.

Keywords: Credit bubbles; Financial intermediaries; Financial crises; Risk shifting (search for similar items in EconPapers)
JEL-codes: G01 G18 G21 G32 (search for similar items in EconPapers)
Date: 2023
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Working Paper: Foreseen Risks (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:212:y:2023:i:c:s0022053123001023

DOI: 10.1016/j.jet.2023.105706

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