This project has two parts. The first part is concerned with developing models for analyzing competition among financial intermediaries. The role of competition in the banking industry is of particular interest. In contrast to most other countries, the US has a long tradition of encouraging competition among a large number of banks. Banks have many special features which mean that standard economic analyses of competition cannot be directly applied. These special features include their role as information gathering and processing institutions and the fact that there are significant switching costs for customers. Models which take account of these features and allow their effect on competition to be analyzed will be developed. Four areas that the project will focus on are (i) competition and the costs of bank failure; (ii) branch networks and competition; (iii) price-setting competition; (iv) competition and risk-taking behavior by banks. In previous work, methods for the analysis of competitive markets with adverse selection were developed. Adapting ideas developed in the context of games with incomplete information, these techniques allow one to deal easily with situations that might be intractable in an extensive form game. In the second part of the proposal, these techniques will be extended to dynamic contests and to deal with moral hazard as well as adverse selection.
