The Role of Financial Intermediaries in Macroeconomics
Staveley-O'Carroll, James Ormonde
Since its inception, the Modigliani-Miller capital structure irrelevancy principle has limited researchers' interest in the role of financial intermediaries in macroeconomics. However, due to the spread of financial crises in emerging markets in the 1980s and 1990s, and the global financial collapse of 2008, the focus of much academic work has turned to rigorously modeling these entities. Chapter one surveys the past and current literature on all types of financial intermediaries (market makers, traditional banks, and hedge funds, among others) and discusses their role in dissemination of asymmetric information, real business cycle fluctuations, and financial crashes and contagion. In chapter two, I build a two-frequency sequential trade model which generates sharp endogenous asset price movements caused by slow dissemination of asymmetric information about economic fundamentals. The key mechanism used in the model employs a Glosten-Migrom market maker who gradually infers the value of the fundamental by trading with both uninformed and imperfectly informed agents. Information becomes "trapped" as purchases by the uninformed agent mask informative sales; a sudden price correction occurs as soon as the market maker discovers the true value of the fundamental. I also study the factors that influence the duration of the information dissemination process. In chapter three, I build a two-country DSGE model with multiple assets, incomplete markets, and an endogenous optimizing banking sector, that is capable of recreating some of the important trends and linkages observed in the financial data. International financial markets during the past several decades have been characterized by a significant rise in gross international equity flows, increased prominence of non-traditional financial institutions, and globalization of the banking sector. In particular, I demonstrate that financial liberalization leads to an increase in a country's gross international asset holdings and to a positive net equity position. Finally, the model lays the groundwork for addressing many of the global banking regulation issues (for example, capital requirements and bankruptcy resolutions) that are now emerging in the field of international finance.
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