TCF set

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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   4
    planning at date 0).
       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                       dividend i1 at date 1.


    Impatients consume [i1+p]           ( 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
                                                                     9
     MARKETS TO WHICH AGENTS HAVE ACCESS.
 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
Differences:
             claims in financial markets),
            incompatibility with financial markets,
            consumer’s LT claim fully pledgeable.
    VARIANTS
    (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         withdraw (         is an equilibrium)
          receives
                                           if
                                           withdraws,
                                           if does not.       11
ANTI-RUN POLICIES

     suspension of convertibility,
     credit line,
      LOLR,
     interbank and other liquidity markets.
                                               12
III.   HETEROGENEOUS CONSUMER HORIZONS:
            GORTON - PENNACCHI (1990)

Consumers have different probabilities of experiencing shock.
DD with 3 twists:
(1) R uncertain (       or    ) not commonly observed at date 1.




(2)    random and unobservable (       or    )

       “Potential liquidity
       traders” ()

       “LT investors”
            (1-)                                                  13
To simplify, 2 states



(3) Speculator (preferences           ) : learns state at date 1, can buy
    shares.
    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               14
             investors buy).
 DEBT AS A LOW INFORMATION INTENSITY SECURITY

 if

 Discussion.




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