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A Theory of Liquidity and Regulation of Financial Intermediation

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Author Info
EMMANUEL FARHI
MIKHAIL GOLOSOV
ALEH TSYVINSKI

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Abstract

This paper studies a Diamond-Dybvig model of providing insurance against unobservable liquidity shocks in the presence of unobservable trades. We show that competitive equilibria are inefficient. A social planner finds it beneficial to introduce a wedge between the interest rate implicit in optimal allocations and the economy's marginal rate of transformation. This improves risk sharing by reducing the attractiveness of joint deviations where agents simultaneously misrepresent their type and engage in trades on private markets. We propose a simple implementation of the optimum that imposes a constraint on the portfolio share that financial intermediaries invest in short-term assets. Copyright Copyright © 2009 The Review of Economic Studies Limited.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1467-937X.2009.00540.x
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Publisher Info
Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 76 (2009)
Issue (Month): 3 (07)
Pages: 973-992
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Handle: RePEc:bla:restud:v:76:y:2009:i:3:p:973-992

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  1. Chiappori, Pierre-Andre & Macho, Ines & Rey, Patrick & Salanie, Bernard, 1994. "Repeated moral hazard: The role of memory, commitment, and the access to credit markets," European Economic Review, Elsevier, vol. 38(8), pages 1527-1553, October. [Downloadable!] (restricted)
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  2. Hellwig, Martin, 1994. "Liquidity provision, banking, and the allocation of interest rate risk," European Economic Review, Elsevier, vol. 38(7), pages 1363-1389, August. [Downloadable!] (restricted)
  3. Mikhail Golosov, 2007. "Optimal Taxation With Endogenous Insurance Markets," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 487-534, 05. [Downloadable!] (restricted)
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  4. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31. [Downloadable!] (restricted)
  5. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Blackwell Publishing, vol. 70(3), pages 569-587, 07. [Downloadable!] (restricted)
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  6. Richard Arnott & Joseph Stiglitz, 1991. "The Welfare Economics of Moral Hazard," NBER Working Papers 3316, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Diamond, Douglas W, 1997. "Liquidity, Banks, and Markets," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 928-56, October.
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  8. Richard J. Arnott & Joseph E. Stiglitz, 1986. "Moral Hazard and Optimal Commodity Taxation," NBER Working Papers 1154, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Blackwell Publishing, vol. 59(3), pages 427-53, July. [Downloadable!] (restricted)
  10. Gary Gorton & Andrew Winton, 2002. "Financial Intermediation," NBER Working Papers 8928, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Stefania Albanesi, 2006. "optimal taxation of entrepreneurial capital with private information," 2006 Meeting Papers 310, Society for Economic Dynamics. [Downloadable!]
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  12. Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer, vol. 27(2), pages 277-304, January. [Downloadable!] (restricted)
  13. Greenwald, Bruce C & Stiglitz, Joseph E, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 229-64, May. [Downloadable!] (restricted)
  14. repec:cup:cbooks:9780521629560 is not listed on IDEAS
  15. Ricardo Caballero & Arvind Krishnamurthy, 2001. "Smoothing Sudden Stops," NBER Working Papers 8427, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June. [Downloadable!] (restricted)
  17. Hammond, Peter J, 1987. "Markets as Constraints: Multilateral Incentive Compatibility in Continuum Economies," Review of Economic Studies, Blackwell Publishing, vol. 54(3), pages 399-412, July. [Downloadable!] (restricted)
  18. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January. [Downloadable!] (restricted)
  19. von Thadden, Ernst-Ludwig, 1999. "Liquidity creation through banks and markets: Multiple insurance and limited market access," European Economic Review, Elsevier, vol. 43(4-6), pages 991-1006, April. [Downloadable!] (restricted)
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  20. Gary Gorton & Andrew Winton, 2002. "Financial Intermediation," Center for Financial Institutions Working Papers 02-28, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  21. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, 07. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Ricardo J. Caballero & Guido Lorenzoni, 2007. "Persistent Appreciations and Overshooting: A Normative Analysis," NBER Working Papers 13077, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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