Journal Article

Financial Intermediation with Risk Aversion

Martin F. Hellwig

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 67, issue 4, pages 719-742
Published in print October 2000 | ISSN: 0034-6527
Published online October 2000 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/1467-937X.00151
Financial Intermediation with Risk Aversion

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The paper extends Diamond's (1984) analysis of financial intermediation to allow for risk aversion of the intermediary. As in the case of risk neutrality, the agency costs of external funds provided to an intermediary are relatively small if the intermediary is financing many entrepreneurs with independent returns. Even though the intermediary is adding rather than subdividing risks, the underlying large-numbers argument is not invalidated by the presence of risk aversion.

With risk aversion of entrepreneurs as well as the intermediary, financial intermediation provides insurance as well as finance. In contrast to earlier results on optimal intermediation policies under risk neutrality, the paper shows that when an intermediary is financing many entrepreneurs with independent returns, optimal intermediation policies must shift return risks away from risk averse entrepreneurs and impose them on the intermediary or on final investors.

Journal Article.  0 words. 

Subjects: Economics

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