Abstract:

How does heterogeneity in the population affect the functioning of financial market institutions? I answer this question, for two very specific settings, and for two kinds of heterogeneity: differences in time horizon and differences in risk aversion in the population.

Differences in the time horizon of a firm's owners may have effects on the size of an IPO. In a firm jointly owned by a venture capitalist and an entrepreneur, usually the former exits soon after an IPO while the entrepreneur has a longer time horizon. I construct a model that captures this empirical fact and characterize how the size of the IPO depends on the initial ownership structure. An empirical analysis for the U.S. IPO market confirms that the asynchronous dismantlement of ownership affects the size of an IPO in a way consistent with the model. The results suggest that the size decision is distorted in the direction generally favored by the venture capitalist.

To analyze how differences in risk aversion affect bank runs, I add heterogeneous agents and risk-sharing opportunities to a coordination game which represents deposit withdrawals from the banking system. I find that heterogeneity in risk aversion within the population amplifies the effect of the business cycle on the probability of a bank run. In particular, risk-sharing enhances the likelihood of bank runs during bad times. The novel insight is that when there is a risk-sharing motive, fundamentals drive not only individual behavior, but also which individuals are more relevant for the likelihood of a crisis. This mechanism has important consequences for the way we think about policy questions. I discuss three such implications in detail: (1) I show that a policy that facilitates access to banking for previously unbanked individuals generates externalities, and may even decrease welfare of the least risk averse group in the population. (2) I characterize the bias in the estimation of the probability of a banking crisis when heterogeneity is neglected. (3) I show how to correctly calculate the social value of deposit insurance when depositors differ in their risk aversion.