We show that exposure from past business transactions--risk overhang--can reduce activity in related business lines, sometimes to the point where no new trade occurs. Our primary focus is the role of overhang in nonlife insurance market disruptions. Our model predicts that the relative impact,...

Should lenders diversify, as suggested by the intermediation literature, or specialize, as suggested by the corporate finance literature? I model a financial institution's (quot;bank'squot;) choice between these two strategies in a setting where bank failure is costly and loan monitoring adds...

New bank equity must come from somewhere. In general equilibrium, raising bank capital requirements means either that banks produce less short-term debt (as debt holders must become shareholders), or short-term debt is not reduced and the banking system acquires nonbank equity (as the...

We test the predictions of several recent theories of how bank capital affects the rates that banks charge their borrowers. Consistent with previous studies, higher bank capital has a negative impact on loan rates, and this effect is focused on bank-dependent borrowers. Further investigation...

Firms sometimes commit fraud by altering publicly reported information to be more favorable, and investors can monitor firms to obtain more accurate information. We study equilibrium fraud and monitoring decisions. Fraud is most likely to occur in relatively good times, and the link between...

After making a loan, a bank finds out if the loan needs contract enforcement (quot;monitoringquot;); it also decides whether to lay off credit risk in order to release costly capital. A bank can lay off credit risk by either selling the loan or by buying insurance through a credit default swap...

The rise of credit default swaps (CDS) provides creditors with a market-based approach to obtaining protection, but it can also affect lenders' monitoring of the borrowers. We find that after CDS begin trading on a given firm, new loans to that firm are less likely to require collateral and have...

Efficient banks are essential for capitalist economies, yet bank failures result in costly externalities, leading to a potential conflict between the risk choices of private agents that own banks and socially optimal choices. This conflict is particularly severe in transition economies. Evidence...