A theory of liquidity and regulation of financial intermediation

Emmanuel Farhi, Mikhail Golosov, Aleh Tsyvinski

Research output: Contribution to journalArticle

56 Scopus citations

Abstract

This paper studies a Diamond-Dybvig model of providing insurance against unobservable liquidity shocks in the presence of unobservable trades. We show that competitive equilibria are inefficient. A social planner finds it beneficial to introduce a wedge between the interest rate implicit in optimal allocations and the economy's marginal rate of transformation. This improves risk sharing by reducing the attractiveness of joint deviations where agents simultaneously misrepresent their type and engage in trades on private markets. We propose a simple implementation of the optimum that imposes a constraint on the portfolio share that financial intermediaries invest in short-term assets.

Original languageEnglish (US)
Pages (from-to)973-992
Number of pages20
JournalReview of Economic Studies
Volume76
Issue number3
DOIs
StatePublished - 2009

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Fingerprint Dive into the research topics of 'A theory of liquidity and regulation of financial intermediation'. Together they form a unique fingerprint.

  • Cite this