{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

topic10_note - EC372 Bond and Derivatives Markets Topic#10...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
EC372 Bond and Derivatives Markets Topic #10: Financial Intermediation, II R. E. Bailey Department of Economics University of Essex Outline Contents 1 Financial Intermediation as Delegated Monitoring 1 1.1 Principal-Agent relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2 The Holmstrom & Tirole (HT) Model 2 3 Fixed Investment 4 3.1 Direct finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 3.2 Indirect finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.3 Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.4 Credit Market Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 4 Variable Investment 6 Reading: Lecture notes (available online in the CMR) Other references (but not required reading for EC372: 1 Financial Intermediation as Delegated Monitoring Delegated Monitoring Investors delegate responsibility for monitoring borrowers to intermediaries. In the ‘delegated monitoring’ approach investors (but not necessarily all investors) delegate responsibility to an intermediary (e.g., a bank) to monitor the ultimate recipients (borrowers, e.g., firms) of investors’ funds. Such delegation could result from several causes, including: (i) economies of scale (inter- mediaries gather funds from investors and lend to many borrowers); (ii) expertise (intermedi- aries have a comparative advantage in specialist monitoring skills); (iii) ‘lumpy’ (indivisible) investment projects (each firm’s investment project may require the funds of many investors). Aspects of delegated monitoring: 1. Screening – assess borrower’s creditworthiness 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
2. Prevention – check borrower’s behaviour 3. Auditing – penalise borrower’s misbehaviour The classification is taken from Freixas and Rochet, Microeconomics of Banking . 1.1 Principal-Agent relationships Principal-Agent theory: a sketch The principal seeks to control the actions of an agent in the interests of the principal. Suppose principal has complete control over the agent: – treat as a single decision-making unit Suppose principal has incomplete control over the agent: – scope for genuine principal-agent relationship The principal designs rules to give incentives to the agent to act in the principal’s interests Why does the principal have incomplete control over the agent?
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}