Bank's capital structure under non-diversifiable risk

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Abstract

The aim of this paper is to study the design of optimal capital structure of a "large" intermediary when the intermediary faces a non-diversifiable risk, within the standard costly-state-verification (CSV) model. I demonstrate that, under weaker conditions, a "large" intermediary realizes more efficient allocation by issuing both debt and equity than by issuing only debt. Unlike Diamond (1984) and Williamson (1986), the set of optimal contracts involves ex ante monitoring made by shareholders of the intermediary. Changes in parameters, such as the variance of the aggregate risk or the cost of monitoring, affect bankruptcy costs and the capital structure.

Original languageEnglish
Pages (from-to)29-45
Number of pages17
JournalEconomic Theory
Volume20
Issue number1
DOIs
Publication statusPublished - 2002 Aug 1
Externally publishedYes

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Keywords

  • Asymmetric information
  • Capital structure
  • Financial intermediation

ASJC Scopus subject areas

  • Economics and Econometrics

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