Financial intermediaries, markets, and growth

This paper contributes to the literature comparing the relative performance of financial intermediaries and markets by studying an environment in which a trade-off between risk sharing and growth arises endogenously. Financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market, if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. Moreover, intermediaries invest less in the productive technology when they provide more risk-sharing. This creates a trade-off between risk-sharing and growth. We show the balance of intermediaries and market that maximizes welfare depend on parameter values.