Paper #1283

Title:

A model of shadow banking

Authors:

Nicola Gennaioli, Andrei Shleifer and Robert Vishny

Date:

May 2011 (Revised: May 2012)

Abstract:

We present a model of shadow banking in which financial intermediaries originate and trade loans, assemble these loans into diversified portfolios, and then finance these portfolios externally with riskless debt. In this model: i) outside investor wealth drives the demand for riskless debt and indirectly for securitization, ii) intermediary assets and leverage move together as in Adrian and Shin (2010), and iii) intermediaries increase their exposure to systematic risk as they reduce their idiosyncratic risk through diversification, as in Acharya, Schnabl, and Suarez (2010). Under rational expectations, the shadow banking system is stable and improves welfare. When investors and intermediaries neglect tail risks, however, the expansion of risky lending and the concentration of risks in the intermediaries create financial fragility and fluctuations in liquidity over time.

Keywords:

securitization, neglected risk, financial fragility

JEL codes:

E51, E44, G2

Area of Research:

Macroeconomics and International Economics

Published in:

Journal of Finance, Forthcoming

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