Research

Firm Dynamics and Financial Shocks with Oligopolistic Financial Intermediaries

Abstract

This paper studies the macroeconomic effects of oligopolistic competition in the financial intermediation sector. Motivated by a recent increase in the concentration of the US banking industry, I develop a dynamic general equilibrium model with oligopolistic banks and heterogenous firms. Dynamic oligopolistic competition among banks generate endogenous financial frictions that shape equilibrium firm dynamics. I calibrate the model to match credit spreads and firm default rates. I introduce two sources of aggregate shocks: sudden deterioration of bank credit quality and a “big bank” failure (e.g. Lehman Brothers in 2008). In both cases, a more concentrated banking sector exacerbates the impact of the shocks on macroeconomic aggregates by increasing borrowing rates and reducing credit availability. This effect leads to: i) a larger and more persistent investment drop, ii) higher dispersion in marginal productivity of capital and decreased aggregate TFP, and iii) procyclical credit spreads. As an extension, I introduce firms’ endogenous default and find that more concentration in the banking sector leads to a less leveraged production sector and smaller default probabilities.


Keywords: Heterogeneous firms, firm dynamics, banks dynamic oligopoly, dynamic game
JEL classification: G12, E52, E40, E44.