Financial intermediation in the theory of the risk-free rate
This paper constructs a general equilibrium model of the interaction between financial intermediaries and financial markets that sheds some light on the short-term volatility of real interest rates. The main findings of the paper are as follows. When financial intermediaries issue contingent (non-contingent) liabilities, an increase in the consumers' relative risk aversion coefficient decreases (increases) the interest rate. Also, the interest rate rises when capitalists are less risk-averse and financial intermediaries are hit by a liquidity shock.
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