Risk Bearing, Implicit Financial Services, and Specialization in the Financial Industry

32 Pages Posted: 17 Jul 2006

See all articles by J. Christina Wang

J. Christina Wang

Federal Reserve Bank of Boston

Susanto Basu

Boston College, College of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 21, 2005

Abstract

What is the output of financial institutions? And how can we measure their nominal and, more importantly, real value, especially since many financial services are provided without explicit charges? This paper summarizes the theoretical result that, to correctly impute the nominal value of implicit financial service output, the "user cost of money" framework needs to be extended to take account of the systematic risk in financial instruments. This extension is easy to implement in principle: One can continue using the current imputation procedure, and the only change needed is to adjust the reference rates of interest for risk. The paper clarifies why the risk-related income is not part of the output - or equivalently, why risk bearing is not a service - of financial institutions. The paper next argues that, to measure real output, one must first explicitly specify and define the economic services produced by financial firms, a step that is absent from the "user cost of money" theory. Once it is established that only financial services, and not instruments, should be counted as the value added of financial firms, it follows that the quantity of services provided by these institutions is not necessarily in fixed proportion to the volume of instruments. The corollary is that the implicit price of financial services bears no definitive relationship with any reference rate. Instead, price deflators for financial services should be constructed using methods similar to those used for other services.

JEL Classification: G21, D24, O47

Suggested Citation

Wang, J. Christina and Basu, Susanto, Risk Bearing, Implicit Financial Services, and Specialization in the Financial Industry (November 21, 2005). FRB of Boston Public Policy Discussion Paper No. 06-3, Available at SSRN: https://ssrn.com/abstract=917427 or http://dx.doi.org/10.2139/ssrn.917427

J. Christina Wang (Contact Author)

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Susanto Basu

Boston College, College of Arts and Sciences, Department of Economics ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467-3806
United States
617-552-2308 (Fax)

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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