The modern financial system features complicated financial intermediation chains, with each layer performing a certain degree of credit/maturity transformation. We develop a dynamic model in which an entrepreneur borrows from overlapping-generation households via layers of funds, forming a credit chain. Each intermediary fund in the chain faces rollover risks from its lenders, and the optimal debt contracts among layers are time invariant and layer independent. The model delivers new insights regarding the benefits of intermediation via layers: the chain structure insulates interim negative fundamental shocks and protects the underlying cash flows from being discounted heavily during bad times, resulting in a greater borrowing capacity. We show that the equilibrium chain length minimizes the run risk for any given contract and find that restricting credit chain length can improve total welfare once the available funding from households has been endogenized.
Authors
- Acknowledgements & Disclosure
- We thank Mikhail Chernov, Will Diamond, Jason Donaldson, Andrea Eisfeldt, Vincent Glode, Valentin Haddad, Francis Longstaff, Konstantin Milbradt, Giorgia Piacentino, and seminar participants at UCLA Anderson, University of Notre Dame, and Wharton for helpful comments. Zhiguo He acknowledges financial support from the John E. Jeuck Endowment at the University of Chicago Booth School of Business. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w29632
- Published in
- United States of America
