AbstractWe model the demand for transactions services and liquidity in an economy with asymmetrically informed agents. It is shown that informed agents can systematically take advantage of agents who are relatively uninformed but who have unexpected needs to trade. This causes certain financial contracts to endogenously arise because they provide a type of "protection" to the uninformed agents. These contracts have the characteristics of creating a security with a safe return from underlying assets with certain returns. Intermediaries that resemble banks are examples of such a contract, and we provide a rationale for deposit insurance in this context. However, a commercial paper market in conjunction with intermediaries resembling money market mutual funds is another financial contract which provides this same transaction, service, and may well be preferred to the bank financial contract. Deposit insurance would not be needed in this later case, though the need for a government debt market may arise.
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Bibliographic InfoPaper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 34-88.
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