Liquidity and ambiguity: banks or asset markets?

Eichberger, Jürgen and Spanjers, Willy (2009) Liquidity and ambiguity: banks or asset markets? In: Liquidity and Trust in Incomplete Markets; 23-24 Nov 2009, Freiburg i.B., Germany.

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Abstract

This paper studies the impact of incalculable risk (i.e. ambiguity) on two alternative institutional arrangements for financial intermediation in an economy where consumers face uncertain liquidity needs. The ambiguity the consumers experience is modeled by their degree of confidence in their additive beliefs. The optimal liquidity allocation and two institutional arrangements for implementing this allocation are analyzed: a secondary asset market and a competitive banking sector. For full confidence we obtain the well-known result that consumers prefer the deposit contract offered in the competitive banking sector over the asset market, since the former can provide the optimal cross subsidy for consumers with high liquidity needs. With increasing ambiguity this preference will be reversed: the asset market is preferred, since it avoids inefficient liquidation if the bank reserve holdings turn out to be suboptimal.

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