Optimal Intermediation Under Aggregate Consumption Uncertainty (Lazopoulos I.)

Household Strategies

Abstract The paper develops a banking framework where a welfare comparison is made between non-tradable demand deposit and equity contracts. Contrary to the existing literature that relies heavily on smooth preferences assumption to justify the liquidity insurance superiority of the ‘run-prone’ debt contracts over the ‘run-free’ equity contracts, the paper shows that when aggregate consumption uncertainty is introduced, the welfare dominance of deposit contracts emerges for a simpler preference structure as deposit contracts offer more risk-sharing opportunities. The model illustrates that such uncertainty creates a high dispersion between the allocations that can be attained by trading in the secondary market, and therefore the equity contract provides ex ante less risk-sharing to risk-averse consumers than a tailored-made debt contract.
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Libref/ Lazopoulos I. (2010) "Optimal Intermediation Under Aggregate Consumption Uncertainty", University of Surrey Department of Economics Discussion Paper No. 0710, pp. 1 - 34
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