Financial Intermediaries, Markets, and Growth
FRB of Kansas City Working Paper No. 04-02
49 Pages Posted: 5 Aug 2004
Date Written: May 2004
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 depends on parameter values. We also show the optimal mix of two very similar economies can be very different.
Keywords: Financial Intermediaries, Financial Markets, Risk-Sharing, Growth
JEL Classification: E44, G10, G20
Suggested Citation: Suggested Citation