Andrea Modena (University of Bonn)

“Risk Pooling, Intermediation Efficiency, and the Business Cycle”

Abstract. We develop a tractable macro-finance model in which entrepreneurs cannot pool idiosyncratic risks across firms due to restricted market participation. Costly risk pooling is provided by financial intermediaries who also issue safe assets via balance sheet leverage. We characterize the general equilibrium effects that associate intermediation costs to the dynamics of output and show that higher (lower) cost efficiency fosters (weakens) growth but also amplifies (dampens) its fluctuations. The model predicts negative relationships between banks’ intermediation costs-to assets ratio and the business cycle and banks’ leverage and the business cycle, which we find to hold for the US economy.