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Working Papers (2003), ESSEC Business School

Bank Financing Strategies, Diversification and Securization

MARTEL Jocelyn , MOKRANE M.

This article follows from Diamond and Dybvig (1983) in the analysis of the role of a bank as a financial intermediary in project financing and risk sharing. In an environment where risk averse depositors face two types of risk (liquidity and macroeconomic risk) and a profit maximizing bank which must decide on whether or not to finance a "new" risky investment, we show that the optimal solution depends on the information revealed by the bank and the depositors level of relative risk aversion. As an alternative to a pure deposit strategy, we show that securitization leads to overinvestment since the bank cannot follow a separating strategy which would tigger a bank run. Finally, we describe one possible method to achieve the first best solution with a pure deposit contract.

MARTEL, J. and MOKRANE, M. (2003). Bank Financing Strategies, Diversification and Securization. ESSEC Business School.