Strategic Behavior in Capital Markets and Asset Prices

In this paper we study the impact of the degree of concentration of a financial system on the aggregate demand for housing as well as the feedback effect of the size of the mortgage loan market on lenders’ profits, internal capital accumulation, loan losses and potential bailouts. In a general equilibrium framework with endogenous borrowing constraints, we show that, contrary to the traditional view, competitive lenders can generate larger profits and accumulate more internal capital than monopolistic lenders. Furthermore, in the event of a severe economic downturn, a competitive financial system can withstand a financial crisis just as well as a concentrated financial system. We provide empirical evidence consistent with the main predictions of our model.