TCF-set 7 - Princeton University Press

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CONSUMER DEMAND FOR LIQUIDITY
7th set of transparencies for ToCF
Consumers, like firms, may face liquidity shocks.
3 topics:
I. Financial institutions as
 liquidity pools: fundamental (no self-provision)
 insurers (flatten term structure to reduce cost of impatience):
more fragile!
II. Runs
III. Heterogenous consumers and security design.
2
I.
DIAMOND-DYBVIG (1983) - MODEL AND VARIANTS
 Consumer demand:
3
 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.
 Example:
AUTARKY
(Strong form: no financial markets at date 1, not only lack of
planning at date 0).
4
either
or
Social optimum match maturities with consumptions
if independent shocks
5
 not optimal to perfectly insure
 CRRA  1
cu' decreasing
Flattening of the yield curve.
6
IMPLEMENTATION
(1) Deposit contract: can withdraw
at date 1
or
at date 2
(assume can be verified. See below).
(2) Mutual fund
invests
Impatients consume [i1+p]
dividend i1 at date 1.
( p = resale price)
7
Patients get
Not true for more general preferences
mutual fund equalizes only MRS;
more conditions.
8
 JACKLIN CRITIQUE
 General theme: markets conflict with optimal insurance.
 Here: bypass. Invest
if patient:
if impatient: resell to patient depositors (who then
withdraw ).
With
can buy  (%) of value R
back to technological yield curve
DD INSURANCE INCOMPATIBLE WITH EXISTENCE OF FINANCIAL
MARKETS TO WHICH AGENTS HAVE ACCESS.
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 COMPARISON WITH CORPORATE LIQUIDITY DEMAND
Analogies:
 insurance against liquidity shocks
 liquidity costly to create:
return on ST investment
< return on LT investment
need right hoarding + dispatching
 autarky given strong meaning (no trading of
claims in financial markets),
 incompatibility with financial markets,
 consumer’s LT claim fully pledgeable.
VARIANTS
Differences:
(a) OLG: could have i1 = 0
(liquidity
newcomers)
Not IC, though: flat yield curve
10
(b) Macroshocks: Hellwig 1994 on interest rate shocks.
II.
RUNS
Suppose
Preferences :
if patient,
if impatient (but has access to
storage technology 1  1 between dates 1 and 2).
 Suppose now
receives
withdraw (
is an equilibrium)
if
withdraws,
if does not.
11
ANTI-RUN POLICIES
 suspension of convertibility,
 credit line,
LOLR,
 interbank and other liquidity markets.
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III.
HETEROGENEOUS CONSUMER HORIZONS:
GORTON - PENNACCHI (1990)
Consumers have different probabilities of experiencing shock.
DD with 3 twists:
(1) R uncertain (
(2)
or
) not commonly observed at date 1.
random and unobservable (
or
)
“Potential liquidity
traders” ()
“LT investors”
(1-)
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To simplify, 2 states
(3) Speculator (preferences
shares.
) : learns state at date 1, can buy
 SUPPOSE ISSUE EQUITY
order flow in state L:
order flow in state H:
full pooling
loss per potential liquidity trader
= price discount (no such discount if only LT
investors buy).
14
 DEBT AS A LOW INFORMATION INTENSITY SECURITY
 if
 Discussion.
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