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Optimal Intermediation Under Aggregate Consumption Uncertainty

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  • Ioannis Lazopoulos

    (University of Surrey)

Abstract

The 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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File URL: http://www.fahs.surrey.ac.uk/economics/discussion_papers/2010/DP07-10.pdf
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Bibliographic Info

Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0710.

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Length: 34 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:sur:surrec:0710

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Keywords: financial intermediation; aggregate uncertainty; deposit contracts; equity contracts.;

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