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Abstract
We examine the relation between intensity of competition in the loan market and risk of bank failure, in a model with adverse selection. As well established, the presence of the two opposite margin and risk-shifting effects creates conditions for nonmonotonicity: the conventional competition-fragility view may be challenged at high interest rates. These rates may however be too high to be compatible with oligopolistic equilibrium conditions. The challenging competition-stability view has been argued in terms of a representative borrower managing the profitability-safeness trade-off under moral hazard. However, the representative borrower assumption is not innocuous, playing down by construction the margin effect. The paper considers the adverse selection situation where that trade-off is managed by banks facing heterogeneous borrowers, and shows analytically, in the case of a trapezoidal distribution of idiosyncratic and systemic risk factors, that the conventional view is always valid.
Original language | English |
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Pages (from-to) | 622-638 |
Number of pages | 17 |
Journal | Journal of Public Economic Theory |
Volume | 23 |
Issue number | 4 |
DOIs | |
Publication status | Published - Aug 2021 |
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CUBE: Católica Lisbon Research Unit in Business and Economics
Fundação para a Ciência e a Tecnologia
1/01/20 → 31/12/23
Project: Research