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Borrower's moral hazard, risk premium, and welfare: a comparison of universal and stand-alone banking systems

Banerji, Sanjay; Basu, Parantap

Authors

Parantap Basu



Abstract

Does the unification of retail and investment banking necessarily heighten risk in financial markets? Using a simple two period intertemporal model with borrower's moral hazard and uninsured risk, we argue that the integration in financial service markets under universal banking could give rise to a greater risk sharing arrangement. This could eliminate the stock market premium attributed to borrower's moral hazard. Absent any other frictions, we show that there is an unambiguous output and welfare gain from switching to a universal banking system from retail banking because of this efficient risk sharing. This welfare gain is higher in economies prone to greater information friction caused by borrower's moral hazard.

Citation

Banerji, S., & Basu, P. (in press). Borrower's moral hazard, risk premium, and welfare: a comparison of universal and stand-alone banking systems. Journal of Economic Asymmetries, 12(1), https://doi.org/10.1016/j.jeca.2015.01.003

Journal Article Type Article
Acceptance Date Jan 31, 2015
Online Publication Date Feb 24, 2015
Deposit Date Dec 1, 2016
Publicly Available Date Dec 1, 2016
Journal Journal of Economic Asymmetries
Electronic ISSN 1703-4949
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 12
Issue 1
DOI https://doi.org/10.1016/j.jeca.2015.01.003
Keywords Moral hazard; Information friction; Risk premium
Public URL http://eprints.nottingham.ac.uk/id/eprint/39089
Publisher URL http://www.sciencedirect.com/science/article/pii/S1703494915000043
Copyright Statement Copyright information regarding this work can be found at the following address: http://creativecommons.org/licenses/by-nc-nd/4.0

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Copyright Statement
Copyright information regarding this work can be found at the following address: http://creativecommons.org/licenses/by-nc-nd/4.0





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