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Liquidity, Banks, and Markets

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  • Diamond, Douglas W

Abstract

This paper examines the roles of markets and banks when both are active, characterizing the effects of financial market development on the structure and market share of banks. Banks lower the cost of giving investors rapid access to their capital and improve the liquidity of markets by diverting demand for liquidity from markets. Increased participation in markets causes the banking sector to shrink, primarily through reduced holdings of long-term assets. In addition, increased participation leads to longer-maturity real and financial assets and a smaller gap between the maturity of financial and real assets. Copyright 1997 by the University of Chicago.

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  • Diamond, Douglas W, 1997. "Liquidity, Banks, and Markets," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 928-956, October.
    • Handle: RePEc:ucp:jpolec:v:105:y:1997:i:5:p:928-56
    DOI: 10.1086/262099
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    References listed on IDEAS

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    1. Douglas W. Diamond, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(3), pages 709-737.
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    3. Hellwig, Martin, 1994. "Liquidity provision, banking, and the allocation of interest rate risk," European Economic Review, Elsevier, vol. 38(7), pages 1363-1389, August.
    4. Merton, Robert C, 1987. "A Simple Model of Capital Market Equilibrium with Incomplete Information," Journal of Finance, American Finance Association, vol. 42(3), pages 483-510, July.
    5. Demirguc-Kunt, Ash & Levine, Ross, 1996. "Stock Market Development and Financial Intermediaries: Stylized Facts," The World Bank Economic Review, World Bank, vol. 10(2), pages 291-321, May.
    6. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
    7. Allen, Franklin & Gale, Douglas, 1994. "Limited Market Participation and Volatility of Asset Prices," American Economic Review, American Economic Association, vol. 84(4), pages 933-955, September.
    8. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
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