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Liquidity and Ambiguity: Banks or Asset Markets?

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  • Jürgen Eichberger

    ()
    (University of Heidelberg, Department of Economics)

  • Willy Spanjers

    ()
    (Kingston University, School of Economics)

Abstract

We study the impact of ambiguity on two alternative institutions of financial intermediation in an economy where consumers face uncertain liquidity needs. The ambiguity the consumers experience is modeled by the degree of confidence in their additive beliefs. We analyze the optimal liquidity allocation and two institutional settings for implementing this allocation: a secondary asset market and a bank deposit contract. For full confidence we obtain the well-known result that consumers prefer the bank deposit contract over the asset market, since the former can provide the optimal cross subsidy for consumers with high liquidity needs. With increasing ambiguity this preference will be reversed: the asset market is preferred, since it avoids inefficient liquidation if the bank reserve holdings turn out to be suboptimal.

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Bibliographic Info

Paper provided by University of Heidelberg, Department of Economics in its series Working Papers with number 0444.

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Length: 39 pages
Date of creation: Jun 2007
Date of revision: Jun 2007
Handle: RePEc:awi:wpaper:0444

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Keywords: Financial institutions; Liquidity; Ambiguity; Choquet Expected Utility.;

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  1. Jürgen Eichberger & David Kelsey, 1999. "E-Capacities and the Ellsberg Paradox," Theory and Decision, Springer, vol. 46(2), pages 107-138, April.
  2. Chateauneuf, Alain & Eichberger, Jurgen & Grant, Simon, 2007. "Choice under uncertainty with the best and worst in mind: Neo-additive capacities," Journal of Economic Theory, Elsevier, vol. 137(1), pages 538-567, November.
  3. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
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  5. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
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  7. Jacklin, Charles J & Bhattacharya, Sudipto, 1988. "Distinguishing Panics and Information-Based Bank Runs: Welfare and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 568-92, June.
  8. V.V. Chari & Ravi Jagannathan, 1984. "Banking Panics," Discussion Papers 618, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. David Kelsey & Willy Spanjers, 2004. "Ambiguity in Partnerships," Economic Journal, Royal Economic Society, vol. 114(497), pages 528-546, 07.
  10. Jurgen Eichberger & Simon Grant & David Kelsey, 2006. "Updating Choquet Beliefs," Discussion Papers 0607, Exeter University, Department of Economics.
  11. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  12. Subrata Ghatak & Willy Spanjers, 2007. "Monetary policy rules in transition economies: the impact of ambiguity," International Journal of Development Issues, Emerald Group Publishing, vol. 6(1), pages 26-37, June.
  13. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  14. Krugman, Paul (ed.), 2007. "Currency Crises," National Bureau of Economic Research Books, University of Chicago Press, edition 0, number 9780226454641, September.
  15. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, vol. 60(6), pages 1255-72, November.
  16. Ross Levine, 1999. "Financial development and growth: where do we stand?," Estudios de Economia, University of Chile, Department of Economics, vol. 26(2 Year 19), pages 113-136, December.
  17. Ghirardato, Paolo & Marinacci, Massimo, 2002. "Ambiguity Made Precise: A Comparative Foundation," Journal of Economic Theory, Elsevier, vol. 102(2), pages 251-289, February.
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