Speculative and precautionary demand for liquidity in competitive banking markets

Dietrich, Diemo and Gehrig, Thomas (2021) Speculative and precautionary demand for liquidity in competitive banking markets. Systemic Risk Centre Discussion Papers (110). Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Abstract

We demonstrate that the co-existence of different motives for liquidity preferences profoundly affects the efficiency of financial intermediation. Liquidity preferences arise because consumers wish to take precautions against sudden and unforeseen expenditure needs, and because investors want to speculate on future investment opportunities. Without further frictions, the co-existence of these motives enables banks to gain efficiencies from combining liquidity insurance and credit intermediation. With standard financial frictions, banks cannot reap such economies of scope. Indeed, the co-existence of a precautionary and a speculative motive can cause efficiency losses which would not occur if there were only a single motive. Specifically, if the arrival of profitable future investment opportunities is sufficiently likely, such co-existence implies inefficient separation, pooling, or even non-existence of pure strategy equilibria. This suggests that policy implications derived solely from a single motive for liquidity demand can be futile.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.systemicrisk.ac.uk/
Additional Information:	© 2021 The Author(s)
Divisions:	Systemic Risk Centre
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	D - Microeconomics > D1 - Household Behavior and Family Economics > D11 - Consumer Economics: Theory D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E21 - Macroeconomics: Consumption; Saving; Aggregate Physical and Financial Consumer Wealth E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E22 - Capital; Investment (including Inventories); Capacity G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L22 - Firm Organization and Market Structure: Markets vs. Hierarchies; Vertical Integration; Conglomerates; Subsidiaries
Date Deposited:	05 Jun 2023 11:15
Last Modified:	14 Sep 2024 04:25
URI:	http://eprints.lse.ac.uk/id/eprint/118869

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