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Why Do Financial Intermediares Exist?

Why Do Financial Intermediares Exist?. The Lemons Problem: Akerlof (QJE – 1970)

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Why Do Financial Intermediares Exist?

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  1. Why Do FinancialIntermediares Exist? • The Lemons Problem: Akerlof (QJE – 1970) • Suppose you want to buy a car. 10 cars are available for purchase in the marketplace. As an uninformed buyer, you are unable to distinguish between good cars and bad cars. Good cars have an open-market value of $4,500, while bad cars have an open-market value of $1,500. Based upon your unique knowledge and entrepreneurial ability, you can generate $6,000 in revenue (not profit) if you are able to obtain a good car, but only $2,000 in revenue if you obtain a bad car. Furthermore, it is common knowledge that 50% of all cars in the marketplace are good cars (and hence, the remaining 50% are bad cars). Assuming you are a risk-neutral, profit-maximizing investor:

  2. Why Do FinancialIntermediares Exist? • Delegated Monitoring: Diamond (JB – 1984) • Agency Cost Example:

  3. Why Do FinancialIntermediares Exist? • Other Explanations • Liquidity Argument – Gorton & Pencchi (JF – 1990) • Credit Availability – Peterson & Rajan (JF/QJE-’94/’95) • Information Story – Berlin and Loeys (JF – 1988)

  4. Are Bank Loans Unique? • Eugene Fama – JME (1985) • Empirical Evidence • Conclusions:

  5. MBA Extension: Local Bank Rates • What is the average 30-year fixed mortgage interest rate in Lubbock? • What are the average fees associated with originating these loans? • What drives local mortgage rates?

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