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Opacity: Insurance and Fragility

Ryuichiro Izumi

No 2019-005, Wesleyan Economics Working Papers from Wesleyan University, Department of Economics

Abstract: What are the effects of banks holding opaque, complex assets? Should regulators require bank assets to be more transparent? I study these questions in a model of fnancial intermediation where opacity determines how long the realized value of an asset remains unknown. By allowing a bank to sell assets before the realization is known, opacity provides insurance to the bank's depositors. However, higher opacity also increases depositors' incentives to join a bank run. In choosing the level of opacity, therefore, a bank faces a trade-off between providing insurance and increasing fragility. If depositors can accurately observe the level of opacity, banks will choose the socially-effcient level. If depositors are unable to observe this choice, however, banks will have an incentive to become overly opaque and regulation to limit opacity can improve welfare.

Keywords: Opacity; Bank runs; Insurance; Banking regulation (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2019-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-ias and nep-rmg
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