CONSUMER DEMAND FOR LIQUIDITY 7th set of transparencies for ToCF

2 Consumers, like firms, may face liquidity shocks. II. Runs III.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!

3 I. DIAMOND-DYBVIG (1983) - MODEL AND VARIANTS Consumer demand:

4 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: 

5 match maturities with consumptions Social optimum if independent shocks either or

6 not optimal to perfectly insure Flattening of the yield curve. CRRA  1 cu' decreasing

7 dividend i 1 at date 1. IMPLEMENTATION (assume can be verified. See below). (2)Mutual fund invests Impatients consume [i 1 +p] ( p = resale price) (1)Deposit contract: can withdraw at date 1 or at date 2

8 Not true for more general preferences mutual fund equalizes only MRS; more conditions. Patients get

9 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

10 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 i 1 = 0(liquidity newcomers) Not IC, though: flat yield curve (b) Macroshocks: Hellwig 1994 on interest rate shocks.

11 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)

12 ANTI-RUN POLICIES suspension of convertibility, credit line, LOLR, interbank and other liquidity markets.

13 (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 liquidity traders” (  ) “LT investors” (1-  ) (2) random and unobservable ( or )

14 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

15 Discussion. if  DEBT AS A LOW INFORMATION INTENSITY SECURITY