Banks, Markets, and the Allocation of Risks in an Economy

Martin Hellwig

No 97-35, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim, Sonderforschungsbereich 504, University of Mannheim

Abstract: The paper discusses the role of banks and markets in the allocation of risks in an economy. Starting from a discussion of risk allocation in the Arrow-Debreu model, it criticizes the view that banks and markets are substitutes. Instead it is argued that markets are made by intermediaries and intermediaries in turn rely on - interbank - markets for risk management. The analysis raises the question why traditional contractual arrangements in banking leave banks subject to risks associated with macro shocks, which are in principle contractable in an incentive-compatible way. Several explanations for this phenomenon are discussed.

Pages: 30 pages
Date: 1997-05-15
Note: It is a pleasure to acknowledge helpful discussions with and comments from Charles Calomiris, James Dow, Thomas Gehrig, Hans Gersbach, and Markus Staub. Financial support from the Deutsche Forschungsgemeinschaft is gratefully acknowledged.
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