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The Allocation of Liability: Why Financial Intermediation?

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  • Wang, Tianxi

Abstract

The paper proposes that the organization of financial markets is decided by the allocation of the liability to repay investors. Based on the liability allocation, the paper examines all possible modes of organizing finance and monitoring in an economy a la Townsend (1979). The equilibrium mode is either Financial Intermediation (FI) where the monitor alone takes the liability, or Conglomeration where it is taken by a Conglomerate composed of entrepreneurs and the monitor. Conglomeration also implements the benefit of diversification, which thus does not drive FI. Moreover, opposed to what Diamond (1984) would predict, monitoring costs advantage FI.

Suggested Citation

  • Wang, Tianxi, 2009. "The Allocation of Liability: Why Financial Intermediation?," Economics Discussion Papers 2957, University of Essex, Department of Economics.
    • Handle: RePEc:esx:essedp:2957
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