Two players simultaneously decide whether or not to acquire new weapons in an arms race game. Each player's type determines his propensity to arm. Types are private information, and are independently drawn from a continuous distribution. With probability close to one, the best outcome for each player is for neither to acquire new weapons (although each prefers to acquire new weapons if he thinks the opponent will). There is a small probability that a player is a dominant strategy type who always prefers to acquire new weapons. We find conditions under which the unique Bayesian-Nash equilibrium involves an arms race with probability one. However, if the probability that a player is a dominant strategy type is sufficiently small, then there is an equilibrium of the cheap-talk extension of the game where the probability of an arms race is close to zero.

We use a moral hazard model to compare monitored (nontraded) bank loans and traded (nonmonitored) bonds as sources of external funds for industry. We contrast the theoretical conditions that favor each system with the historical conditions prevailing when these financial systems evolved during the British and German industrial revolutions. To study persistence, we consider an entry model where financiers take the industrial structure as given when they lend and firms take the financial system as given when they borrow. We show multiple equilibria can exist, compare equilibria in welfare terms, and discuss their robustness to coordination between lenders and borrowers.

We use a moral hazard model to compare monitored (nontraded) bank loans and traded (nonmonitored) bonds as sources of external funds for industry. We contrast the theoretical conditions that favor each system with the historical conditions prevailing when these financial systems evolved during the British and German industrial revolutions. To study persistence, we consider an entry model where financiers take the industrial structure as given when they lend and firms take the financial system as given when they borrow. We show multiple equilibria can exist, compare equilibria in welfare terms, and discuss their robustness to coordination between lenders and borrowers.