Collective Moral Hazard and the Interbank Market

The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.

Liquidity Choice and Misallocation of Credit

This paper studies a novel type of misallocation of credit between investments of varying liquidity. One type of investment is more liquid, i.e., its return is more pledgeable, and the other is more productive. Low liquidities of both investment types imply that the allocation of credit is constrained inefficient and that there is overinvestment in the liquid type. Constrained inefficient equilibria feature non-positive, i.e., one less than or equal the economy’s growth rate, and yet too high interest rate, too much investment and too little consumption. Financial development can reduce long-term welfare and output in a constrained inefficient equilibrium if it raises the liquidity of the liquid type. I show a maximum liquid asset ratio or a simple debt tax can achieve constrained efficiency. Introducing government bonds can make Pareto improvement whenever it does not raise the interest rate.

Constrained Efficiency in a Human Capital Model

This paper investigates whether capital and human capital are over-accumulated in an incomplete market economy. As in Dávila et al. (2012), whether capital is over-accumulated depends on how the pecuniary externalities affect insurance and redistribution. In a human capital economy, however, not only capital but also human capital generates externalities and an additional channel arises that has implications for the overaccumulation (under-accumulation) of capital (human capital). The income sources of the poor and the correlation between wealth and human capital are crucial for the implication of pecuniary externalities. Realistically calibrated models exhibit under-accumulation (overaccumulation) of capital (human capital). (JEL D52, D62, I26, J22, J24, J31)

Efficient Constrained Combinatorial Auctions

The seminal work by Green and Laffont [(1977) characterization of satisfactory mechanisms for the revelation of preferences for public goods, Econometrica 45, 427–438] shows that efficient mechanisms with Vickrey–Clarke–Groves prices satisfy the properties of dominant-strategy incentive compatible (DSIC) and individually rational in the quasilinear utilities model. Nevertheless in many real-world situations some players have a gap between their willingness to pay and their ability to pay, i.e., a budget. We show that once budgets are integrated into the model then Green and Laffont’s theorem ceases to apply. More specifically, we show that even if only a single player has budget constraints then there is no deterministic efficient mechanism that satisfies the individual rationality and DSIC properties. Furthermore, in a quasilinear utilities model with [Formula: see text] nonidentical items and [Formula: see text] players with multidimensional types, we characterize the sufficient and necessary conditions under which Green and Laffont’s theorem holds in the presence of budget-constrained players. Interestingly our characterization is similar in spirit to that of Maskin [(2000) Auctions, development and privatization: Efficient auctions with liquidity-constrained buyers, Eur. Econ. Rev. 44, 667–681] for Bayesian single-item constrained-efficiency auctions.