When are banks better than markets? Comment on Zimper (2013)
Economics Letters, 2016, vol. 147, issue C, 171-173
Zimper (2013) claims that in the basic Diamond–Dybvig model trade in a competitive asset market can implement the first best. I show that the argument of Zimper is incorrect as it stands: Zimper derives his result assuming that the consumers choose investment levels that are individually suboptimal. The corrected argument shows that laissez-faire markets do not provide any liquidity insurance. However, if consumers can trade in markets in the banking economy, banks do not provide any insurance either. Whether or not banks are better than markets, therefore, crucially depends on the extent of trading restrictions.
Keywords: Liquidity insurance; Banks; Asset market; Competitive equilibrium; Incomplete markets (search for similar items in EconPapers)
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