Inefficient Liquidity Provision

27 Pages Posted: 22 Feb 2017 Last revised: 1 Mar 2017

John Geanakoplos

Yale University - Cowles Foundation

Kieran James Walsh

University of Virginia - Darden School of Business

Date Written: February 22, 2017

Abstract

We prove that in competitive market economies with no insurance for idiosyncratic risks, agents will always overinvest in illiquid long term assets and underinvest in short term liquid assets. We take as our setting the seminal model of Diamond and Dybvig (1983), who first posed the question in a tractable model. We reach such a simple conclusion under mild conditions because we stick to the basic competitive market framework, avoiding the banks and intermediaries that Diamond and Dybvig and others introduced.

Keywords: Liquidity, Constrained inefficiency, Diamond-Dybvig models, fire sales

JEL Classification: E44, D5, E43, E6, G18

Suggested Citation

Geanakoplos, John and Walsh, Kieran James, Inefficient Liquidity Provision (February 22, 2017). Cowles Foundation Discussion Paper No. 2077; Darden Business School Working Paper No. 2922020. Available at SSRN: https://ssrn.com/abstract=2922020 or http://dx.doi.org/10.2139/ssrn.2922020

John D Geanakoplos (Contact Author)

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3397 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://cowles.econ.yale.edu/P/au/d_gean.htm

Kieran James Walsh

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

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