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Money as a risk-pooling institution: Diversification under quality uncertainty

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  • Teng, Jimmy

Abstract

Under barter, risk-averse agents may forgo otherwise profitable trade because consuming a single good exposes them to undiversified quality risk, tightening participation constraints. Money relaxes these constraints by allowing agents to pool risk through diversified consumption. We formalize this in a mean–variance framework where monetary exchange separates selling from buying decisions, transforming concentrated bilateral risk into portfolio-level consumption risk. When product qualities are independent, effective consumption variance equals sigma_squared divided by N, expanding feasible trades. Welfare gains from money increase with product variety, quality uncertainty, and risk aversion, arising independently of matching frictions or information asymmetries.

Suggested Citation

  • Teng, Jimmy, 2026. "Money as a risk-pooling institution: Diversification under quality uncertainty," Economics Letters, Elsevier, vol. 262(C).
    • Handle: RePEc:eee:ecolet:v:262:y:2026:i:c:s0165176526000601
    DOI: 10.1016/j.econlet.2026.112866
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    JEL classification:

    • 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
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Systems; Standards; Regimes; Government and the Monetary System
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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