ABSTRACT [article]

We build a model in which financial intermediaries provide insurance to households against idiosyncratic liquidity shocks. Households can invest in financial markets directly if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. From a growth perspective, this can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies can grow more slowly than more market-oriented economies, which is consistent with some recent empirical evidence. We show that the mix of intermediaries and markets that maximizes welfare under a given level of financial development depends on economic fundamentals.

Keywords and Phrases: Financial intermediaries, financial markets, risk-sharing, Growth

JEL Classification Numbers: E44, G10, G20

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