Investment and deposit contracts under costly intermediation and aggregate volatility

Pierre Richard Agénor, Joshua Aizenman

Research output: Contribution to journalArticlepeer-review

3 Scopus citations

Abstract

This paper examines how volatility affects investment and the form of deposit contracts in a three-period model where capital formation is financed by bank credit and lenders face state verification and enforcement costs. Firms face both idiosyncratic and aggregate shocks, and agents are initially risk neutral. We show that intermediation costs magnify the incidence of macroeconomic volatility on banks' expected losses and have an adverse effect on investment. With risk-averse consumers, the impact of banks' expected losses on investment is mitigated because the equilibrium deposit contract provides partial insurance against adverse macroeconomic shocks.

Original languageEnglish
Pages (from-to)263-275
Number of pages13
JournalInternational Review of Economics and Finance
Volume15
Issue number3
DOIs
StatePublished - 26 Jun 2006
Externally publishedYes

Keywords

  • Credit market imperfections
  • Financial contracts
  • Investment

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