An Incentive Problem in the Dynamic Theory of Banking

This paper develops a continuous-time model of liquidity provision by banks, in which customers can deposit and withdraw their funds strategically. The strategic withdrawal option introduces an incentive-compatibility problem that turns the problem of designing deposit contracts into a non-standard, non-convex optimal control problem. The paper develops a solution method for this problem and shows that, in this more general frame-work, the insights obtained from the traditional banking models change considerably, up to the point of liquidity provision becoming impossible. The continuous-time framework allows to discuss the problem elegantly and may help to make this part of the banking literature more operational in the sense of modern asset pricing theory.Liquidity; deposit contracts; banking; incentive compatibility; continuous time; dynamic programming

Liquidity Creation through Banks and Markets : Multiple Insurance and Limited Market Access

The paper surveys theories of the intertemporal allocation of funds through demand deposits and anonymous markets, first separately and then in an integrated model. It reviews some work on the role of market frictions and asset characteristics, and suggests that the interplay between these two is crucial in explaining the observed coexistence of demand deposits and anonymous markets.banks; markets; liquidity; demand deposits; incentive compatibility

Asymmetric Information, Bank Lending and Implicit Contracts : The Winner's Curse

The purpose of this note is to point out an error in a widely cited paper by Sharpe (1990) on long-term bank-firm relationships and to provide a correct analysis of the problem. The model studies repeated lending under asymmetric information which leads to winner's-curse type distortions of competition. Contrary to the claims in Sharpe (1990), this game only has an equilibriuim in mixed strategies, which features a partial informational lock-in by firms and random termination of lending relationships.Author-Name: banking relationships; competition under asymmetric information; informational lock-in; auctions

The Changing Corporate Governance Paradigm: Implications for Transition and Developing Countries

The rapidly growing literature studying the relationship between legal origin, investor protection, and finance has stimulated an important debate in academic circles. It has also generated a number of applied research projects and strong policy statements. This paper discusses the implications, in particular for developing and transition countries, from this literature. We conclude that its focus on the plight of small investors is too narrow when applied to these countries. We argue that this group is unlikely to play an important role in most developing and transition countries. External investors may still be crucial, but they are more likely to come in as strategic investors or creditors. The paper also proposes a broader paradigm including other stakeholders and mechanisms of governance in order to better understand the problems facing these countries and generate policy implications that compensate for the weaknesses of capital markets.http://deepblue.lib.umich.edu/bitstream/2027.42/39648/3/wp263.pd

The European Bond Markets under EMU

In this paper, we document how in the wake of monetary unification the markets for Euro-area sovereign and private-sector bonds have become increasingly integrated. Issuers and investors alike have come to regard the Euro-area bond market as a single one. Primary and secondary bond markets have become increasingly integrated on a pan-European scale. Issuance of corporate bonds has taken off on an unprecedented scale in continental Europe. In the process, both investors and issuers have reaped the considerable benefits afforded by greater competition in the underwriting of private bonds and auctioning of public ones, and by the greater liquidity of secondary markets. Bond yields have converged dramatically in the transition to EMU. The persistence of small and variable yield differentials for sovereign debt under EMU indicates that Euro-area bonds are still not perfect substitutes. However, to a large extent this does not reflect persistent market segmentation but rather small differentials in fundamental risk. Liquidity differences play at most a minor role, and this role appears to arise partly from their interaction with fundamental risk. The challenges still lying ahead are numerous. They include the unbalance between the German-dominated futures and the underlying cash market; the vulnerability of the cash markets' prices to free-riding and manipulation by large financial institutions; the possibility of joint bond issuance by Euro-area countries; the integration of clearing and settlement systems in the Euro-area bond market, and the participation of new accession countries' issuers to this market.Euro, bond market, financial integration, bond yield differential

The Changing Corporate Governance Paradigm : Implications for Transition and Developing Countries

The rapidly growing literature studying the relationship between legal origin, investor protection, and finance has stimulated an important debate in academic circles. It has also generated a number of applied research projects and strong policy statements. This paper discusses the implications, in particular for developing and transition countries, from this literature. We conclude that its focus on the plight of small investors is too narrow when applied to these countries. We argue that this group is unlikely to play an important role in most developing and transition countries. External investors may still be crucial, but they are more likely to come in as strategic investors or creditors. The paper also proposes a broader paradigm including other stakeholders and mechanisms of governance in order to better understand the problems facing these countries and generate policy implications that compensate for the weaknesses of capital markets.corporate governance; corporate law; economic transition; economic development

The Changing Corporate Governance Paradigm: Implications for Transition and Developing Countries

The rapidly growing literature studying the relationship between legal origin, investor protection, and finance has stimulated an important debate in academic circles. It has also generated a number of applied research projects and strong policy statements. This paper discusses the implications, in particular for developing and transition countries, from this literature. We conclude that its focus on the plight of small investors is too narrow when applied to these countries. We argue that this group is unlikely to play an important role in most developing and transition countries. External investors may still be crucial, but they are more likely to come in as strategic investors or creditors. The paper also proposes a broader paradigm including other stakeholders and mechanisms of governance in order to better understand the problems facing these countries and generate policy implications that compensate for the weaknesses of capital markets.corporate governance, corporate law,economic transition, economic development

Liquidity

This is a survey of the literature on liquidity provision through banks. I first formulate the basic model underlying the modern literature on liquidity provision for households and then introduce the more recent literature on liquidity provision through banks and markets. Then I turn to liquidity provision on the asset side of banks' balance sheets and conclude with a brief discussion of how the two sides of the balance sheet interact.liquidity; banks; markets

Incentive Compatibility and Differentiability: New Results and Classic Applications

This note provides several generalizations of Mailath's (1987) result that incentive compatibility plus separation implies differentiability. The new results extend the theory to classic models in finance such as Leland and Pyle (1977), Glosten (1989), and De Marzo and Duffie (1999), that were not previously covered.Adverse selection, separation, differentiable strategies, incentive-compatibility

Outside Finance, Dominant Investors and Strategic Transparency

This paper studies optimal financial contracts and product market competition under a strategic transparency decision. When firms seeking outside finance resort to actively monitored debt in order to commit against opportunistic behaviour, the dominant lender can influence corporate transparency. More transparency about a firm's competitive position has both strategic advantages and disadvantages: in general, transparency results in higher variability of profits and output. Thus lenders prefer less information dissemination, as this protects firms when in a weak competitive position, while equityholders prefer more disclosure to maximize profitability when in a strong position. We show that bank-controlled firms will be opaque, while shareholder- run firms prefer more transparency. In fact, we can predict a clustering of characteristics associated with bank dominance: opaqueness, low variability of profits, slightly reduced average profits, uncertainty about assets in place, and relatively high financing needs all should be observed jointly for bank controlled firms.corporate governance; transparency; bank finance; product market competition; capital structure