Optimal Intermediation Under Aggregate Consumption Uncertainty
AbstractThe paper develops a banking framework where a welfare comparison is made between non-tradable demand deposit and equity contracts. Contrary to the existing literature that relies heavily on smooth preferences assumption to justify the liquidity insurance superiority of the ‘run-prone’ debt contracts over the ‘run-free’ equity contracts, the paper shows that when aggregate consumption uncertainty is introduced, the welfare dominance of deposit contracts emerges for a simpler preference structure as deposit contracts offer more risk-sharing opportunities. The model illustrates that such uncertainty creates a high dispersion between the allocations that can be attained by trading in the secondary market, and therefore the equity contract provides ex ante less risk-sharing to risk-averse consumers than a tailored-made debt contract.
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Bibliographic InfoPaper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0710.
Length: 34 pages
Date of creation: Sep 2010
Date of revision:
financial intermediation; aggregate uncertainty; deposit contracts; equity contracts.;
Other versions of this item:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-09-18 (All new papers)
- NEP-BAN-2010-09-18 (Banking)
- NEP-DGE-2010-09-18 (Dynamic General Equilibrium)
- NEP-MIC-2010-09-18 (Microeconomics)
You can help add them by filling out this form.
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