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Financial intermediaries, markets, and growth

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  • Falko Fecht
  • Kevin X. D. Huang
  • Antoine Martin

Abstract

We build a model in which financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. We show that the mix of intermediaries and market that maximizes welfare under a given level of financial development depends on economic fundamentals. We also show the optimal mix of two structurally very similar economies can be very different.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 04-24.

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Date of creation: 2004
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Handle: RePEc:fip:fedpwp:04-24

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Keywords: Intermediation (Finance) ; Financial markets ; Risk;

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