How does financial market concentration affect capital allocation? We propose a complete-markets model in which real investment and financial price impact are jointly determined in general equilibrium. We identify a two-way feedback mechanism whereby price impact induces misallocation and misallocation raises price impact. The mechanism is stronger if productivity is low or productivity dispersion is high. Given rising dispersion, the model can rationalize trends in corporate discount rates, cash holdings, investment, asset prices, and capital reallocation over the last two decades, even when market concentration is relatively stable. Overall, our findings suggest that financial market concentration may hamper allocative efficiency.

Using variation in bank scope generated by the stepwise repeal of the Glass–Steagall Act in the US, we show that the deregulation of universal banks allowed them to finance firms with 14% higher volatility. This increase in risk is compensated by lasting improvements in firms’ total factor productivity of 3%. Using bank scope-expanding mergers to identify shocks to universal banks’ private information about borrower firms, we provide evidence that informational economies of scope across loans and non-loan products account for the firm-level real effects of universal banking.

What determines the supply of good collateral? We study a dynamic model in which borrowers must exert effort to maintain collateral quality and markets become illiquid when average quality is too low. Average quality grows quickly when it is high initially, but deteriorates or grows slowly otherwise. As such, even long-run market conditions are sensitive to a wide array of fundamental and non-fundamental shocks. Recoveries from illiquidity can occur, but only if funding is inefficiently rationed for some time. Policymakers without commitment may fall into intervention traps in which ex-post efficient liquidity injections cause permanent declines in collateral quality.

We develop a theory of information spillovers in sovereign bond markets in which investors can learn about default risk before trading in primary and secondary markets. If primary markets are structured as multi-unit discriminatory-price auctions, an endogenous winner’s curse leads to strategic complementarities in information acquisition. Shocks to default risk in one country may trigger crisis episodes with widespread information acquisition, sharp increases in the level and volatility of yields in risky countries, low and stable yields in safe countries, market segmentation, and arbitrage profits between primary and secondary markets. These predictions are consistent with the dynamics of auction informativeness during the Eurozone Sovereign Debt Crisis, which we measure using the reaction of secondary market yields to primary market yields.

We examine how portfolio regulations affect risk sharing between financial institutions with market power. Unconstrained access to complete markets permits flexible exploitation of market power and induces inefficient risk sharing. Appropriate portfolio restrictions counteract this, improving liquidity and risk sharing by bundling securities with offsetting strategic incentives. However, excessive regulation can be counterproductive, destroying gains from trade. An application of our theory shows that cross-asset spillovers are critical for policy evaluation: in general equilibrium, risk sharing can improve even if certain asset-specific liquidity measures deteriorate. We also discuss the effects of asymmetric regulation for different institutions.

Using bid-level data from discriminatory auctions for Mexican government bonds, we demonstrate that asymmetric information about default risk is a key friction in sovereign bond markets. We document that large bidders achieve higher bid-acceptance rates than other bidders despite paying no more for executed bids. We then propose a new model of primary markets in which investors may differ in wealth, risk aversion, market power, and information. Only asymmetric information can qualitatively account for our empirical finding, and asymmetric information about rare disasters can quantitatively match bidding and yield moments. Counterfactuals reveal substantial effects of asymmetric information on yields.