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A Theory of Liquidity and Regulation of Financial Intermediation

  • Emmanuel Farhi
  • Mikhail Golosov
  • Aleh Tsyvinski

This paper studies a Diamond-Dybvig model of providing insurance against unobservable liquidity shocks in the presence of unobservable trades. We show that competitive equilibria are inefficient. A social planner finds it beneficial to introduce a wedge between the interest rate implicit in optimal allocations and the economy's marginal rate of transformation. This improves risk sharing by reducing the attractiveness of joint deviations where agents simultaneously misrepresent their type and engage in trades on private markets. We propose a simple implementation of the optimum that imposes a constraint on the portfolio share that financial intermediaries invest in short-term assets. Copyright , Wiley-Blackwell.

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File URL: http://hdl.handle.net/10.1111/j.1467-937X.2009.00540.x
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Article provided by Oxford University Press in its journal The Review of Economic Studies.

Volume (Year): 76 (2009)
Issue (Month): 3 ()
Pages: 973-992

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Handle: RePEc:oup:restud:v:76:y:2009:i:3:p:973-992
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  1. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2002. "Optimal Indirect and Capital Taxation," NajEcon Working Paper Reviews 391749000000000449, www.najecon.org.
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  17. Gary Gorton & Andrew Winton, 2002. "Financial Intermediation," Center for Financial Institutions Working Papers 02-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
  18. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31.
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  24. repec:cup:cbooks:9780521629560 is not listed on IDEAS
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