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Essays on the Microeconomics of Financial Market Structure and Performance

  • Author(s): Krishnamurthy, Prasad
  • Advisor(s): Card, David
  • et al.
Abstract

How does financial market structure affect business growth and consumer welfare? Microeconomic theory presumes that market outcomes are a result of the equilibrium interaction of agents with differing objectives. This dissertation develops and tests microeconomic models of the credit and deposit markets . Parts 1 and 2 emphasize the importance of asymmetric information and strategic interaction, respectively, in determining financial market structure and performance.

Part 1 provides new evidence on the relationship between financial market structure and firm growth. I develop an equilibrium model of firms who can access debt capital and capital from banks that monitor their borrowers. In this model, (1) shifts in the supply of bank credit have the largest effect on firms who have just enough capital to acquire finance, and (2) financial integration dampens the quantity effects of shocks to credit supply, but exacerbates the quantity effects of shocks to credit demand.

I test these hypotheses by exploiting the history of bank-branching deregulation in the United States. I use the differential timing of state deregulation to trace the causal channel that runs from financial integration to firm growth. I find that for mid-sized establishments, financial integration lowered the association between local credit supply and business growth. My findings suggest that the excess volatility in business growth in unintegrated markets may entail significant allocative inefficiencies.

Part 2 investigates the contribution of deposit market competition and consumer preferences to banking market structure and pricing. I develop a general model of spatial competition where consumers' higher willingness to pay for firms with more locations generates an externality in firms' location decisions. I characterize the equilibrium of this model and provide novel analytical results for prices, markups and limiting market shares.

I then consider the application of this model to the market for bank deposits. The model generates predictions on (1) the density of branches, (2) the pattern of within-market and across-market concentration, (3) the relationship between concentration and market size, (4) the relationship between branching networks and deposit prices, and (5) the dispersion of deposit prices. I utilize the history of bank branch deregulation to test the predictions of this model by comparing free branching to unit branching--one bank/one branch--states. The empirical tests are broadly consistent with the hypothesis that strategic competition in branch networks plays a role in determining market structure.

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