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Money, Banking and Competition

Paper Session

Friday, Jan. 3, 2025 10:15 AM - 12:15 PM (PST)

San Francisco Marriott Marquis, Foothill C
Hosted By: Association of Financial Economists & American Finance Association
  • Chair: Kose John, New York University

Smart Banks

Alkis Georgiadis-Harris
,
University of Warwick
Maxi Guennewig
,
University of Bonn
Yuliyan Mitkov
,
University of Bonn

Abstract

Since Diamond and Dybvig (1983), banks have been viewed as inherently fragile. We challenge this view in a general mechanism design framework, where we allow for flexibility in the design of banking mechanisms while maintaining limited commitment of the intermediary to future mechanisms. We find that the unique equilibrium outcome is efficient. Consequently, runs cannot occur in equilibrium. Our analysis points to the ultimate source of fragility: banks are fragile if they cannot collect and optimally respond to useful information during a run and not because they engage in maturity transformation. We link our banking mechanisms to recent technological advances surrounding ‘smart contracts,’ which enrich the practical possibilities for banking arrangements.

Payments, Reserves, and Financial Fragility

Itay Goldstein
,
University of Pennsylvania
Ming Yang
,
University College London
Yao Zeng
,
University of Pennsylvania

Abstract

We propose a dynamic theory of payments and fragility, highlighting a conflict between money’s payment and various non-payment functions (e.g., store of value). We show that agents make payments and produce only when money reserves are abundant and when the payment function is relatively more important than non-payment functions. Otherwise, history-dependent equilibria arise in which an agent’s payment and production decisions depend on the payment history of other agents within an equilibrium, giving rise to fragilities. The theory explains why payments frequently encounter delays and interruptions even if the reserve is always accepted as means of payment. Improving payment technologies may not eliminate such fragility when reserves remain scarce and valuable for non-payment functions. The theory helps explain the evolution of money and payment systems, encompassing historical metallic and commodity payments, modern bank payments, cross-border payments, and contemporary digital payment systems.

Market Power, Fund Proliferation, and Asset Prices

Marco Loseto
,
University of Chicago
Federico Mainardi
,
University of Chicago

Abstract

We develop an equilibrium model of the passive mutual fund industry to analyze the welfare and asset pricing implications of fund proliferation. In the model, fund proliferation results from product entry decisions of oligopolistic, profit-maximizing asset management firms. Introducing a new fund increases competition but lowers the cost of launching additional funds in the future. More efficient firms introduce new funds earlier and grow larger. Despite the increase in market concentration, fund proliferation benefits households by lowering investment costs. We estimate the model by matching entry patterns observed in the data and find that the largest asset management firms enjoy substantial scale economies compared to the rest of the market. Removing the most efficient asset managers reduces household welfare, primarily due to reduced cost efficiency rather than reduced competition. We close the model by deriving the equilibrium asset prices, which are jointly determined with the number of funds operating in the market. Our estimates indicate that fund proliferation can amplify the long-run price impact of passive institutional investors by as much as 40%.

Discussant(s)
Philip Dybvig
,
Washington University-St. Louis
Wei Xiong
,
Princeton University
Anna Pavlova
,
London Business School
JEL Classifications
  • G2 - Financial Institutions and Services
  • G2 - Financial Institutions and Services