Can financial intermediation induce endogenous fluctuations

Sanjay Banerji, Joydeep Bhattacharya and Ngo Long

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: This paper studies the possibility of endogenous fluctuations caused by activities of financial intermediaries. Risk-averse agents borrow from banks and invest in a risky two-state capital technology. The probability of success with the technology is assumed to be decreasing in the amount of capital invested. In a complete information setting with intermediation, the efficient loan contract achieves complete risk sharing but the amount invested in the risky project is smaller than the loan size. This “income effect” is responsible for the endogenous generation of complex dynamics. In the absence of intermediation, the economy studied cannot exhibit any cyclical fluctuations.

Date: 2004-10-01
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Related works:
Journal Article: Can financial intermediation induce endogenous fluctuations (2004)
Working Paper: Can Financial Intermediation Induce Endogenous Fluctuations? (2004)
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