TY - JOUR
T1 - Monitoring the monitor
T2 - An incentive structure for a financial intermediary
AU - Krasa, Stefan
AU - Villamil, Anne P.
N1 - * We thank Jeff Lacker, Steve Williamson, the Editor, an Associate Editor, and a referee of this journal for useful comments. We also gratefully acknowledge the financial support of the National Science Foundation (SES 89-09242).
PY - 1992/6
Y1 - 1992/6
N2 - This paper studies financial intermediation (i.e., delegated monitoring) in a costly state verification model. There are a finite number of agents, thus the intermediary cannot fully diversify its portfolio and is subject to default risk. The role of the intermediary is to satisfy simultaneously the different portfolio preferences of borrowers and lenders. Two questions arise when a delegated monitor is subject to non-trivial default risk: (a) What arrangement solves the problem of monitoring the monitor? (b) What intermediary portfolio accomplishes optimal asset transformation between borrowers and lenders? Unlike previous delegated monitoring studies, the law of large numbers is not sufficient to obtain our results. Instead, we appeal to a stronger results, the large deviation principle, which establishes that convergence in the law of large numbers is exponential.
AB - This paper studies financial intermediation (i.e., delegated monitoring) in a costly state verification model. There are a finite number of agents, thus the intermediary cannot fully diversify its portfolio and is subject to default risk. The role of the intermediary is to satisfy simultaneously the different portfolio preferences of borrowers and lenders. Two questions arise when a delegated monitor is subject to non-trivial default risk: (a) What arrangement solves the problem of monitoring the monitor? (b) What intermediary portfolio accomplishes optimal asset transformation between borrowers and lenders? Unlike previous delegated monitoring studies, the law of large numbers is not sufficient to obtain our results. Instead, we appeal to a stronger results, the large deviation principle, which establishes that convergence in the law of large numbers is exponential.
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U2 - 10.1016/S0022-0531(05)80048-1
DO - 10.1016/S0022-0531(05)80048-1
M3 - Article
AN - SCOPUS:0001105013
SN - 0022-0531
VL - 57
SP - 197
EP - 221
JO - Journal of Economic Theory
JF - Journal of Economic Theory
IS - 1
ER -