Abstract: We extend Merton (1969)’s analysis of capital allocation and consumption-savings choices to the case in which asset management is delegated to several privately informed agents. With a continuum of agents, mean-field control techniques yield a simple and intuitive solution: capital reallocation is linear in relative performance, and managers’ fees are proportional to assets-under-management. We show that these properties do not obtain in the single agent case. We also show that continuation utilities are exposed to idiosyncratic risk and increasingly unequal between managers. Finally, investment is lower than under symmetric information because incentive constraints reduce risk-sharing.
Abstract: This paper identifies a novel bank-run externality. We show that regulations intended to enhance the safety of large national banks may disproportionately increase the likelihood of bank runs among smaller banks. A minor shock can prompt a cascading chain reaction of deposit withdrawals among many regional banks, even if those banks are not severely distressed—such simultaneous exodus from small institutions generates novel systemic vulnerabilities beyond the traditional channel through interbank connectivity. We extend global game models by incorporating realistic deposit mobility across multiple risky banks, alongside the conventional risk-free option (typically the sole outside option in models studying bank-runs). Our framework captures the interaction between strategic complementarity in run/stay decisions among multiple substitutes—a dynamic that remains underexplored in the literature.
Discussant: William Diamond, University of Wisconsin-Madison
Abstract: Creditors are tempted to examine collateral assets of uncertain value, but costly information acquisition ultimately reduces financing capacity. A pecking order emerges. Debt provides greater financing capacity than equity: unlike equity, creditors own the asset only if the borrower defaults, discouraging costly asset examination. Probabilistic asset ownership can be further diluted by introducing intermediaries between borrower and creditor, leading to a new theory of financial intermediation and credit chains.
Our theory rationalizes the seemingly excessive complexity of financial architecture: the optimal chain arises in a decentralized equilibrium and is characterized by a sequence of heterogeneous intermediaries that discourages information production.
