Abstract: The paper takes a mechanism design approach to dynamic capital allocation and risk-sharing between an investor (the principal) and asset managers (the agents). Incentive-compatibility implies that managers with better idiosyncratic performance get larger fees, capital, and continuation utilities. This generates an endogenous distribution of utilities across managers, which is a state variable of the optimal control problem of the principal.With a continuum of agents, this gives rise to a Bellman equation in an infinite-dimensional space, which we solve with mean-field techniques. Optimal compensation is proportional to assets-under-management and costly exposure to idiosyncratic risk is optimal but lowers risky investment.
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: Investors are tempted to examine collateral assets of uncertain value. The information cost is ultimately borne by the asset owner, reducing her financing capacity. A pecking order emerges. Debt generates a greater financing capacity than equity: unlike equity, creditors own the asset only if the borrower defaults, discouraging costly asset examination. The probabilistic asset ownership can be further diluted by introducing intermediaries between the borrower and the 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 sequences multiple heterogeneous intermediaries to discourage information production.
