Learning by Lending:the Informational Role of Financial Intermediaries

Abstract

This paper presents a model of financial intermediation that emphasizes the dynamic nature of information acquisition conducted by intermediaries. I think of intermediaries as institutions that are able to learn and transfer relevant information about various economic sectors dynamically. In this model, intermediation arises endogenously and is welfare improving; however, it also introduces a problem of asymmetric information into the economy. I find the optimal contracts that intermediaries (informed principals) offer to households (uninformed agents) in a general equilibrium competitive environment and fully characterize the nature of the intermediaries’ market and the evolution of their portfolios. I find that when the quality of information is independent of the scale of the intermediary’s investment, the market is fully competitive at all times, and that competition disciplines intermediaries, i.e. asymmetric information and moral hazard issues are overcome by the market. However, when larger investment scale is associated with better information, the equilibrium features one intermediary with the threat of entry of uninformed intermediaries. In this scenario, asymmetric information distorts the allocation of funds across agents in the economy and the equilibrium features inefficiencies. Finally, for the fully competitive case, I focus on the dynamic nature of the model and show how intermediaries with these properties can amplify and propagate shocks to the real economy.