EconPapers    
Economics at your fingertips  
 

Financial Fragility and Over-the-Counter Markets

Bruno Sultanum

No 16-4, Working Paper from Federal Reserve Bank of Richmond

Abstract: This paper studies the interaction between financial fragility and over-the-counter markets. In the model, the financial sector is composed of a large number of investors divided into different groups, which are interpreted as financial institutions, and a large number of dealers. Financial institutions and dealers trade assets in an over-the-counter market la Duffie et al. (2005) and Lagos and Rocheteau (2009). Investors are subject to privately observed preference shocks, and financial institutions use the balanced team mechanism, proposed by Athey and Segal (2013), to implement an efficient risk-sharing arrangement among its investors. I show that when the market is more liquid, in the sense that the searchfriction is mild, the economy is more likely to have a unique equilibrium and, therefore, is not fragile. However, when the search friction is severe, I provide examples with run equilibria?where investors announce low valuation of assets because they believe everyone else in their financial institution is doing the same. In terms of welfare, I find that, conditional on bank runs existing, the welfare impact of the search friction is ambiguous. The reason is that, during runs, trade is inefficient and, as a result, a friction that reduces trade during runs has the potential to improve welfare. This result is in sharp contrast with the existing literature which suggests that search friction has a negative impact on welfare.

JEL-codes: D82 E58 G01 G21 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2016-04-13
New Economics Papers: this item is included in nep-ban, nep-dge, nep-fmk, nep-pr~ and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
https://www.richmondfed.org/-/media/richmondfedorg ... 2016/pdf/wp16-04.pdf Full text (application/pdf)

Related works:
Journal Article: Financial fragility and over-the-counter markets (2018) Downloads
Working Paper: Financial Fragility and Over-the-counter Markets (2017) Downloads
Working Paper: Financial fragility and over-the-counter markets (2014) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedrwp:16-04

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Working Paper from Federal Reserve Bank of Richmond Contact information at EDIRC.
Bibliographic data for series maintained by Christian Pascasio ().

 
Page updated 2024-02-21
Handle: RePEc:fip:fedrwp:16-04