CONSUMER DEMAND FOR LIQUIDITY

7th set of transparencies for ToCF

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Consumers, like firms, may face liquidity shocks.

II.

RunsIII. Heterogenous consumers and security

design.

3 topics:I. Financial institutions as

liquidity pools: fundamental (no self-provision) insurers (flatten term structure to reduce cost of impatience):

more fragile!

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I. DIAMOND-DYBVIG (1983) - MODEL AND VARIANTS

Consumer demand:

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Technological yield curve

with (no dominance)

Technological yield curve:

Self-provision of liquidity is inefficient

Intuitions: hoarding liquidity is costly, liquidity is wasted if no liquidity shock.

AUTARKY(Strong form: no financial markets at date 1, not only lack of planning at date 0).

Example:

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match maturities with consumptionsSocial optimum

if independent shocks

either or

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not optimal to perfectly insure

Flattening of the yield curve.

CRRA 1 cu' decreasing

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dividend i1 at date 1.

IMPLEMENTATION

(assume can be verified. See below).

(2) Mutual fund

invests

Impatients consume [i1+p] ( p = resale price)

(1) Deposit contract: can withdraw at date 1

or at date 2

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Not true for more general preferences

mutual fund equalizes only MRS; more conditions.

Patients get

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JACKLIN CRITIQUE

General theme: markets conflict with optimal insurance.

back to technological yield curve

DD INSURANCE INCOMPATIBLE WITH EXISTENCE OF FINANCIAL

MARKETS TO WHICH AGENTS HAVE ACCESS.

Here: bypass. Invest

if patient:if impatient: resell to patient depositors (who then withdraw ).

With can buy (%) of value R

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COMPARISON WITH CORPORATE LIQUIDITY DEMAND insurance against liquidity shocks liquidity costly to create:

return on ST investment< return on LT investment

need right hoarding + dispatching

Analogies

:

autarky given strong meaning (no trading of claims in financial markets), incompatibility with financial markets,consumer’s LT claim fully pledgeable.

Differences:

VARIANTS

(a) OLG: could have i1 = 0 (liquidity newcomers)

Not IC, though: flat yield curve

(b) Macroshocks: Hellwig 1994 on interest rate shocks.

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II. RUNS

Suppose

Preferences : if patient, if impatient (but has access to

storage technology 1 1 between dates 1 and 2).

receives if

withdraws,if does not.

Suppose now withdraw ( is an equilibrium)

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ANTI-RUN POLICIES

suspension of convertibility, credit line,

LOLR, interbank and other liquidity markets.

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(1) R uncertain ( or ) not commonly observed at date 1.

III. HETEROGENEOUS CONSUMER HORIZONS: GORTON - PENNACCHI (1990)

Consumers have different probabilities of experiencing shock.DD with 3 twists:

“Potential liquiditytraders” ()

“LT investors”(1-)

(2) random and unobservable ( or )

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To simplify, 2 states

SUPPOSE ISSUE EQUITY

= price discount (no such discount if only LT investors buy).

(3) Speculator (preferences ) : learns state at date 1, can buy shares.

order flow in state L:

order flow in state H:

loss per potential liquidity trader

full pooling

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Discussion.

if

DEBT AS A LOW INFORMATION INTENSITY SECURITY