Survey_AG_2005

Abstract

To illustrate these ideas, we use a model with four essential elements: (i) There is a trade-off between asset returns and asset maturity: short-term assets mature quickly but have low returns, long-term assets have higher returns but take longer to mature, (ii) Following Diamond and Dybvig (1983), we model consumers' liquidity preference as uncertainty about time preference. Ex ante, consumers are identical, ex post, they are either early consumers, who only value immediate consumption, or late consumers, who only value future consumption, (iii) Intermediaries are modeled as risk-sharing institutions that provide liquidity insurance to consumers. Intermediaries pool the consumers' endowments and invest them in a mixture of short-term and long-term assets. They offer consumers risk-sharing contracts that provide a better mix of liquidity and returns than consumers could achieve on their own. (iv) Interbank markets allow intermediaries to trade aggregate risks and, in particular, to hedge against unexpected liquidity shocks. Because of the transaction costs of participation, consumers do not participate in the interbank markets.