Essays on Market Microstructure in Finance and Health

Abstract

The first part of this dissertation studies financial stability of maturity transforming institutions (banks) under variations of capital structure. As banks are financed by more uninsured deposits as opposed to equity, a larger group of depositors can draw on a common pool of finite liquidity and the likelihood of runs changes. I use a global games structure similar to Goldstein and Pauzner (2005) to obtain a unique threshold equilibrium. Our results imply that capital regulation of firms financed by uninsured debt should be tailored to particular scenarios for market liquidity or regulation should distinguish between firms according to their target asset liquidity.<br /> The second part of this dissertation studies the impact of recovery values after bankruptcy on stability of financial firms against runs. When financial firms invest in illiquid, long-term assets and finance by liquid, uninsured debt, the potential of a liquidity squeeze arises: When tomorrow too many investors prematurely demand back their deposits the firm needs to transform illiquid assets to cash quickly. If the number of withdrawing agents is too large, due to asset illiquidity the firm cannot satisfy all claims and goes into default (run). If the firm defaults, agents who did not claim their deposit receive zero. Knowing this in advance, uninsured debt investors face a coordination problem. Invoking the theory of global games, I derive a unique equilibrium of the game which allows us to study ex ante probability of runs as a function of the model's primitives capital structure, liquidity mismatch and the composition of recovery value.<br /> As main contribution of the paper, I show that high recovery values achieved by cost efficient bankruptcy proceedings or generous government interventions are never desirable from a stability perspective and only sometimes desirable from a consumer perspective. I show, the probability of runs increases in both, slope and intercept of recovery value. Thus, larger recovery values are detrimental to firm stability since it increases incentives to run on the firm.<br /> The third part of this dissertation studies redistributional effects of competition between private and public insurance on health insurance markets based on the example of Germany. Public and private insurance coexist and are mutually exclusive. Private insurance maximizes profits. Public insurance balances budget and is financed by an income tax with a cap. In addition, customers of public insurance have the option to opt out once income is sufficiently large. On a more abstract level, we study a two-dimensional linear taxation problem with price cap, opt-out for high types under a budget balancing constraint and regulation. We derive a condition under which a unique, redistributive, budget balancing public contribution rate exists. Considering a systematic improvement of the population's health and income, we show that even though the change clearly improves the population's characteristics, the public contribution rate might increase. Healthy and wealthy customers may opt out and insure privately so that an improvement does not benefit all customers via redistribution in the public insurance but instead is pocketed by private insurance. Increases in correlation between income and health may increase public health prices to keep a balanced budget: On the one hand, less wealthy types insure publicly and become on average less healthy which causes additional costs to public insurance. On the other hand, higher earning types become more healthy after the increase in positive correlation but may opt out so that the gain in health and decrease in costs is lost to private insurance.