Financial system design and liquidity provision by banks and markets in a dynamic economy [An article from: Journal of International Money and Finance]

This digital document is a journal article from Journal of International Money and Finance, published by Elsevier in 2004. The article is delivered in HTML format and is available in your Amazon.com Media Library immediately after purchase. You can view it with any web browser.

Description:
This paper contributes to the literature on financial system design by comparing markets and banks in a dynamic economy. Investors trade off their liquidity needs against the high returns on illiquid investments. Both the banking system and the market can provide partial liquidity insurance to investors. We consider full market participation as well as limited market participation. We demonstrate that the full-participation market with intergenerational trading can provide more liquidity than one without. Insurance is provided through wealth transfer across generations, instead of cross-subsidization across contemporaneous types as is the case in the finite economy. Given a full-participation market that allows trading across generations, only banks with initial capital can provide additional liquidity. In a limited-participation market with uncertainty about trading types, an intergenerational bank (with or without initial capital) provides additional insurance to investors. The need for trade is eliminated. Finally, if there is no uncertainty about trading types, then an intergenerational bank with initial capital eliminates the need for trading and improves welfare for all. An intergenerational bank without initial capital improves welfare for people who do not trade.