Liquidity, Pledgeability, and the Nature of Lending

Douglas W. Diamond; Yunzhi Hu; Raghuram G. Rajan

doi:10.3386/w28377

Liquidity, Pledgeability, and the Nature of Lending

Douglas W. Diamond, Yunzhi Hu & Raghuram G. Rajan

Working Paper 28377

DOI 10.3386/w28377

Issue Date January 2021

We develop a theory of how corporate lending and financial intermediation change based on the fundamentals of the firm and its environment. We focus on the interaction between the prospective net worth or liquidity of an industry and the firm’s internal governance or pledgeability. Variations in prospective liquidity can induce changes in the nature, covenants, and quantity of loans that are made, the identity of the lender, and the extent to which the lender is leveraged. We offer predictions on how these might vary over the financial cycle.

Diamond and Rajan thank the Center for Research in Security Prices at Chicago Booth for research support. Rajan also thanks the Fama-Miller Center, the Stigler Center and IGM at Chicago Booth for research support. We are grateful for helpful comments from Ron Kaniel (the editor), the anonymous referee, Jason Roderick Donaldson, Ye Li, Arvind Krishnamurthy, S. ”Vish” Viswanathan, Ming Yang, and conference /seminar participants at the 2019 AEA, FIFI, Chicago Booth, Columbia, SFS Cavalcade, FIRS, Rochester, and IMF. This incorporates some results from a working paper, "Liquidity and Securitization." The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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Liquidity, Pledgeability, and the Nature of Lending

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