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Financial intermediaries, markets, and growth

  • Falko Fecht
  • Kevin Huang
  • Antoine Martin

In many models of financial intermediation, markets reduce welfare because they limit the amount of risk-sharing intermediaries can offer. In this paper we study a model in which markets also promote investment in a productive technology. A trade-off between risk sharing and growth arises endogenously. In the model, financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. We show the mix of intermediaries and market that maximizes welfare depend on parameter values. We also show the optimal mix of two very similar economies can be very different.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 04-02.

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Date of creation: 2004
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Handle: RePEc:fip:fedkrw:rwp04-02
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