A dilution cost approach to financial intermediation and securities markets

Bolton, Patrick and Feixas, Xavier (1998) A dilution cost approach to financial intermediation and securities markets. Financial Markets Group Discussion Papers (305). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

This paper proposes a model of financial markets and corporate finance, with asymmetric information and no taxes, where equity issues, Bank debt and Bond financing may all co-exist in equilibrium. The paper emphasizes the relationship Banking aspect of financial intermediation: firms turn to banks as a source of investment mainly because banks are good at helping them through times of financial distress. The debt restructuring service that banks may offer, however, is costly. Therefore, the firms which do not expect to be financially distressed prefer to obtain a cheaper market source of funding through bond or equity issues. This explains why bank lending and bond financing may co-exist in equilibrium. The reason why firms or banks also issue equity in our model is simply to avoid bankruptcy. Banks have the additional motive that they need to satisfy minimum capital adequacy requirements. Several types of equilibria are possible, one of which has all the main characteristics of a "credit crunch". This multiplicity implies that the channels of monetary policy may depend on the type of equilibrium that prevails, leading sometimes to support a "credit view" and other times the classical "money view".

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 1998 The Authors
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G1 - General Financial Markets > G10 - General
Date Deposited:	05 Jul 2023 09:03
Last Modified:	16 Sep 2023 00:03
URI:	http://eprints.lse.ac.uk/id/eprint/119140

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