as well as numerous seminar participants. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Maryam Farboodi has received financial support from MIT for this research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
as well as numerous seminar participants. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Maryam Farboodi has received financial support from MIT for this research.NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
I develop a model of the financial sector in which endogenous intermediation among debt financed banks generates excessive systemic risk. Financial institutions have incentives to capture intermediation spreads through strategic borrowing and lending decisions. By doing so, they tilt the division of surplus along an intermediation chain in their favor, while at the same time reducing aggregate surplus. I show that a coreperiphery network -few highly interconnected and many sparsely connected banksendogenously emerges in my model. The network is inefficient relative to a constrained efficient benchmark since banks who make risky investments "overconnect", exposing themselves to excessive counterparty risk, while banks who mainly provide funding end up with too few connections. The predictions of the model are consistent with empirical evidence in the literature. * I am extremely grateful to my advisors Douglas Diamond, Lars Hansen, Zhiguo He and Raghuram Rajan for their invaluable input. I am grateful to Alex Frankel, Amin Jafarian and Amit Seru for very helpful comments and suggestions. I would also like to thank
scite is a Brooklyn-based organization that helps researchers better discover and understand research articles through Smart Citations–citations that display the context of the citation and describe whether the article provides supporting or contrasting evidence. scite is used by students and researchers from around the world and is funded in part by the National Science Foundation and the National Institute on Drug Abuse of the National Institutes of Health.