Research in Financial Economics

Princeton University, Princeton NJ

Investigators

Abstract

This research consists of two research projects in financial economics. The first project inves-tigates the role of competition in financial markets. In spite of the general acceptance of the competitive mechanism as an allocation scheme, many observers consider fi-nancial intermediation an exception. Competition is presumed to lead to a "race to the bottom," in which financial intermediaries settle for excessively low levels of contractual guarantees in an attempt to increase volume. This project develops the-oretical models of competition among financial intermediaries that design contracts to attract trading volume, while taking into consideration that traders may choose to default, and that traders differ in credit quality. These theoretical models are used to evaluate arguments for regulation of financial markets, and, in particular, whether competition leads to excessively low levels of contractual guarantees. The second project studies the valuation of certain derivative securities when short-selling restrictions are present, such as in executive stock options.