Ignorant Experts and Financial Fragility
MPRA Paper from University Library of Munich, Germany
We study debt funding markets in which lenders can invest in financial expertise to reduce a cost of acquiring information about the underlying collateral. If the pledgeability of corporate income is low, lenders' information acquisition enhances liquidity, but they reduce expertise acquisition because of a hold-up problem. By contrast, if the pledgeability is high, information acquisition reduces liquidity, so that lenders can extract rents from firms by investing in expertise and creating fear of illiquidity. In this case, as information about collateral decays over time, there is growth in credit and expertise acquisition, making the economy more vulnerable to an aggregate shock. These results suggest that the growth of the financial sector is associated with prevalence of opaque assets and a subsequent crisis.
Keywords: expertise; collateral; information acquisition; information sensitivity; liquidity (search for similar items in EconPapers)
JEL-codes: D83 E44 G01 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-mac
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