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Risk Sharing in a World with Processing Costs: Trading versus Banking
Author(s) -
Bommel Jos van
Publication year - 2008
Publication title -
financial markets, institutions and instruments
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.386
H-Index - 23
eISSN - 1468-0416
pISSN - 0963-8008
DOI - 10.1111/j.1468-0416.2008.00143.x
Subject(s) - market liquidity , transaction cost , monetary economics , consumption (sociology) , search cost , business , economics , microeconomics , social science , sociology
We analyze the bank versus exchange problem in a Diamond Dybvig (1983) economy with exogenous transaction processing costs. We find that processing costs in the market enables the bank to overcome the side trade threat (Jacklin (1987)) and offer some desirable liquidity insurance. Moreover, in the bank equilibrium processing costs are proportional to consumption, while in the market economy early and late consumers incur equal costs. These two effects explain that for a given level of aggregate processing costs, the bank economy is superior. On the other hand, the number of transactions in the bank economy is larger. It is for this reason that if processing costs are proportional to transaction value, and independent of the mechanism used, the exchange economy is superior.