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Open AccessJournal ArticleDOI

Direct versus intermediated finance: An old question and a new answer

Anke Gerber
- 01 Jan 2008 - 
- Vol. 52, Iss: 1, pp 28-54
TLDR
In this paper, the authors consider a closed economy where a risk neutral bank competes with a competitive bond market and show that the bank tends to allocate more capital to lower quality projects but there are some interesting qualifications.
About
This article is published in European Economic Review.The article was published on 2008-01-01 and is currently open access. It has received 2 citations till now. The article focuses on the topics: Risk neutral & Bond market.

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Dissertation

Le choix de la source de dettes par les grandes firmes : le cas français

TL;DR: In this article, the authors show that the decision of a firm to endettement depends on certain caracteristiques of the company, e.g., the caracterismiques of its carteristiques, the carterismique of its managers, and the variables de gouvernance, which play a role in the choix d'endettement.
References
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Posted ContentDOI

Credit Rationing in Markets with Imperfect Information.

TL;DR: In this paper, a model is developed to provide the first theoretical justification for true credit rationing in a loan market, where the amount of the loan and amount of collateral demanded affect the behavior and distribution of borrowers, and interest rates serve as screening devices for evaluating risk.
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A theory of fairness, competition and cooperation

TL;DR: This paper showed that if some people care about equity, the puzzles can be resolved and that the economic environment determines whether the fair types or the selesh types dominate equilibrium behavior in cooperative games.
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INSIDERS AND OUTSIDERS: The Choice between Informed and Arm's-length Debt

TL;DR: In this paper, the authors argue that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun.
Journal ArticleDOI

Financial Intermediation, Loanable Funds, and The Real Sector

TL;DR: In this article, an incentive model of financial intermediation in which firms as well as intermediaries are capital constrained is studied, and how the distribution of wealth across firms, intermediaries, and uninformed investors affects investment, interest rates, and the intensity of monitoring.
Journal ArticleDOI

Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt

TL;DR: In this paper, the authors determine when a debt contract will be monitored by lenders, which is the choice between borrowing directly (issuing a bond, without monitoring) and borrowing through a bank that monitors to alleviate moral hazard.
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Frequently Asked Questions (14)
Q1. What are the contributions in "Direct versus intermediated finance: an old question and a new answer∗" ?

The authors consider a closed economy where a risk neutral bank competes with a competitive bond market. The authors show that the bank tends to allocate more capital to lower quality projects but there are some interesting qualifications. 

Instead, the authors want to point out that there is an additional, much simpler explanation, which does not appeal to very sophisticated bank services like monitoring or contract renegotiation and which seems to have been overlooked so far. However, hard evidence on the relative importance of monitoring, relationship banking and risk diversification may be difficult if not impossible to obtain, so the best the authors can do is to test the predictions of the theoretical models. 

One way to restore market clearing then is to increase the credit volume for the high risk type which further decreases the supply for bonds but at the same time lowers the default risk on the bond market and hence increases the demand for bonds. 

The essential property that the authors need to obtain the results of the paper is that the investment in the bond is increasing in the return it5there is no bank and no bond market, any investor consumes her period zero endowment in t = 1, i.e. the authors assume that there is a storage technology and that capital is non-perishable. 

In the presence of a riskless deposit contract a low interest rate on bonds decreases the investors’ demand for bonds and hence increases the credit volume by the market clearing condition. 

The literature mainly focusses on three aspects that can explain the choice between bank loans and public debt, namely information costs, monitoring and renegotiation. 

In the region where pooling is the optimal choice for the bank (λ < λ∗), thecredit volume is increasing in the risk of type θ1’s project and it is decreasing in the expected return of type θ2’s project. 

In the region where screening is the optimal choice for the bank (λ ≥ λ∗) and where µ1 − K is sufficiently small the credit volume is increasing in the risk of the financed project and decreasing in its expected return. 

In order to rule out multiple equilibria on the bond market the authors will later restrict the parameters of their model such that the best pooling contract always17gives positive profits to the bank. 

in a pooling equilibrium the maximal interest rate factor that banks can pay is given by r∗D = p̄(λ)σ2(µ2 − K) since r∗C = σ2(µ2 − K) is the maximal interest rate factor on credit that type θ2 firms are willing to pay. 

The authors have seen that the bank’s preference for lower quality projects does not only concern the credit volume but also the type of contract (pooling or screening) that is chosen. 

the authors have seen that the credit volume is increasing in the default risk and decreasing in the expected return of the financed projects. 

Their results can be extended to the case where investors can diversify their risk on the bond market to some extent as long as full diversification is not possible. 

Since a firm’s willingness to pay is given by σi(µi−K) there is a trade-off between the success probability and the expected return that determines which firm is driven out of the market.