WORKING PAPER NO.

13-32
ON THE WELFARE PROPERTIES OF FRACTIONAL
RESERVE BANKING




Daniel R. Sanches
Federal Reserve Bank of Philadelphia



August 2013





On the Welfare Properties of Fractional Reserve Banking


Daniel R. Sanches
Federal Reserve Bank of Philadelphia

August 2013




The author thanks Mitchell Berlin, Guido Menzio, and Will Roberds for excellent discussions.

Correspondence to Sanches at Research Department, Federal Reserve Bank of Philadelphia, Ten
Independence Mall, Philadelphia, PA 19106-1574; phone: (215) 574-4358; Fax: (215) 574-4303;
e-mail: Daniel.Sanches@phil.frb.org.

The views expressed in this paper are those of the authors and do not necessarily reflect those of
the Federal Reserve Bank of Philadelphia or the Federal Reserve System. This paper is available
free of charge at www.philadelphiafed.org/research-and-data/publications/working-papers/
ALstract
Monolaiy oconomisls havo long iocognizoo a lonsion Lolwoon lho Lonolls of fiac-
lional iosoivo Lanking, such as lho aLilily lo unooilako moio piollaLlo (long-loim)
invoslmonl oppoilunilios, ano lho oimcullios associaloo wilh fiaclional iosoivo Lank-
ing, such as lho iisk of insolvoncy foi oach Lank. 1ho goal of lhis papoi is lo show lhal
a spocilc foim of piivalo Lank coalilion (a joinl-liaLilily aiiangomonl) allows lho mom-
Lois of lho Lanking syslom lo ongago in fiaclional iosoivo Lanking in such a way lhal
lho solvoncy of oach momLoi Lank is complololy guaianlooo. Unooi lhis aiiangomonl, I
show lhal a lowoi iosoivo ialio usually lianslalos inlo a highoi oxchango valuo of Lank
liaLililios, Lonollling lho consumois who uso lhom as a moans of paymonl.
1j&:J: Lank coalilion, fiaclional iosoivo Lanking, inloiLank ciooil, iosoivo man-
agomonl
J11 |n.]n.n: 1., G.1
1
1. ITHOD\CTIO
Ono of lho main chaiacloiislics of lho moooin Lanking syslom is lho small amounl of
iosoivos in lawful monoy lhal Lanks holo iolalivo lo lho amounl of shoil-loim liaLililios
(such as oomano ooposils) lhoy issuo. Lconomisls usually iofoi lo lhis piaclico as fiac-
lional iosoivo Lanking. 1ho piopononls of fiaclional iosoivo Lanking havo aiguoo lhal a
fiaclional syslom allows Lanks lo oconomizo on non-inloiosl-Loaiing iosoivos, poimilling
lhom lo incioaso lho ioluin on lhoii assols ano, in lho caso of a compolilivo maikol foi
Lank liaLililios, pay a highoi ioluin lo lhoii liaLilily holoois. Implicil in lhis aigumonl is
lho conjocluio lhal a lowoi lovol of iosoivos nocossaiily iosulls in a highoi ioluin (oi smalloi
oiscounl) paio on a pailiculai class of Lank liaLililios: lhoso lhal facililalo paymonls ano
solllomonl (such as Lank nolos ano oomano ooposils). 1his is usually viowoo as a socially
oosiiaLlo oulcomo Locauso ono of lho main funclions of Lanks is lo piovioo liansaclion
soivicos.
Fiaclional iosoivo Lanking is inoooo a supoiioi foim of Lanking pioviooo lhal oach Lank
iolios on an inloiLank maikol lo Loiiow iosoivos in caso il sulois an unusual numLoi of
wilhoiawals. 1ho facl lhal oach Lank holos only a fiaclion of ils oomanoaLlo liaLililios
in lho foim of highly liquio assols makos il piono lo failuio. A lypical concoin is wholhoi
fiaclional iosoivo Lanking ionoois lho Lanking syslom insolvonl in caso inloiLank maikols,
foi somo ioason, fail lo poifoim lho funclion of liansfoiiing iosoivos fiom moio liquio
Lanks lo illiquio Lanks.
1
1hus, lhoio is a cloai lonsion Lolwoon lho Lonolls of fiaclional
iosoivo Lanking, such as lho aLilily lo unooilako moio piollaLlo (long-loim) invoslmonl
oppoilunilios, ano lho oimcullios associaloo wilh lho implomonlalion of fiaclional iosoivo
Lanking, such as lho iisk of insolvoncy foi oach Lank. 1ho goal of lhis papoi is lo invosligalo
wholhoi il is possiLlo lo implomonl a fiaclional iosoivo syslom lhal allows momLoi Lanks lo
lako aovanlago of piollaLlo invoslmonl oppoilunilios ano lhal is safo ano souno. My main
1
Foi inslanco, Fiiooman (100) has aiguoo in favoi of a Lanking syslom in which oach momLoi Lank
holos in iosoivo lho full valuo of ils oomanoaLlo liaLililios. His main concoin is lho slaLilily of lho Lanking
syslom.
2
iosull is lo show lhal a spocilc foim of piivalo Lank coalilion (a joinl-liaLilily aiiangomonl)
allows lho momLois of lho Lanking syslom lo ongago in fiaclional iosoivo Lanking in such
a way lhal lho solvoncy of oach inoivioual momLoi is complololy guaianlooo. As opposoo
lo maikols, lhis Lank coalilion involvos lho moniloiing of lho aclivilios of momLoi Lanks.
Finally, I aiguo lhal lhis kino of Lank coalilion iosomLlos lho cloaiinghouso associalions
lhal havo oovolopoo in lho U.S. in lho 10lh conluiy, as oosciiLoo in Fiiooman ano Schwailz
(1068), Goilon (1084, 108), Goilon ano Mullinoaux (1087), ano Moon ano 1allman (1002,
2000).
I consliucl a ianoom-malching moool in which piivaloly issuoo liaLililios ciiculalo as
a mooium of oxchango. Iooplo mool in paiis ano ioly on Lank liaLililios lo liaoo. 1ho
iooomplion of Lank liaLililios happons poiiooically in a conlializoo localion whoio sollois
who havo solo gooos lo Luyois lako lhoii Lank liaLililios lo claim lhoii faco valuo. 1ho koy
inconlivo pioLlom wilhin lho Lanking syslom aiisos ouo lo hiooon aclion: Il is nocossaiy
lo piovioo Lanks wilh inconlivos lo inouco lhom lo volunlaiily iopoil lho cioalion of Lank
liaLililios ano holo lho appiopiialo lovol of iosoivos. 1o ooal wilh lhis inconlivo pioLlom,
lhoio oxisls a cloaiinghouso associalion (a mochanism) lhal ioquiios momLoi Lanks lo iopoil
lhoii liansaclions, imposos iosoivo ioquiiomonls on oach ono of lhom, ano supoivisos lho
solllomonl ano cloaiing of Lank liaLililios al oach oalo. 1hus, lho kino of moniloiing
pioviooo Ly lho cloaiinghouso allows oach momLoi Lank lo issuo liaLililios lhal ciiculalo as
a mooium of oxchango.
I inilially chaiacloiizo an oquiliLiium allocalion in lho aLsonco of a Lank coalilion. In
lhis caso, a safo ano souno Lanking syslom (i.o., ono in which lhoio is no Lank failuio in
oquiliLiium) nocossaiily involvos an inslilulional aiiangomonl in which oach Lankoi is io-
quiioo lo holo in iosoivo lho full valuo of his oomanoaLlo liaLililios. As shoulo Lo oxpocloo,
oach momLoi Lank is fully solvonl al any momonl so lhal lhis foim of Lanking onsuios lho
slaLilily of lho paymonl syslom. I show lhal such a syslom cosls somolhing foi nonLanks:
1ho ialo of ioluin paio on Lank liaLililios is iolalivoly low Locauso il is nocossaiy lo in-
ouco Lankois lo liulhfully iopoil lho cioalion of Lank liaLililios ano volunlaiily holo lho
appiopiialo lovol of iosoivos. Locauso oach consumoi holos hoi woallh in lho foim of Lank
8
liaLililios, lho oquiliLiium valuo of lhoso liaLililios has a lisl-oiooi olocl on lho wolfaio of
consumois. 1hus, il is oosiiaLlo lo invosligalo lho oxislonco of an inconlivo-foasiLlo schomo
wilhin lho Lanking syslom lhal iosulls in a highoi oquiliLiium valuo of Lank liaLililios ano
lhal piosoivos lho safoly of Lank liaLililios as a moans of paymonl (so lhal liaoois oo nol
oiscounl piivaloly issuoo nolos Locauso of lho possiLilily of lossos ouo lo Lank failuios).
In pailiculai, I chaiacloiizo lho piopoilios of a Lanking syslom in which oach Lankoi
volunlaiily choosos lo Locomo a momLoi of a coalilion lhal will issuo Lank liaLililios lhal
aio oloclivoly joinl oLligalions of ils momLois. Lach Lankoi conlinuos lo issuo liaLililios lhal
ioonlify him as a ooLloi, Lul lho coalilion puLlicly announcos lhal, in lho ovonl in which an
inoivioual Lankoi is unaLlo lo koop his piomisos, olhoi momLois will honoi any oLligalion of
such a momLoi, accoioing lo lhoii joinl capacily. 1his joinl-liaLilily aiiangomonl will allow
momLoi Lanks lo ioouco lho shaio of funos invosloo in non-inloiosl-Loaiing assols ano,
consoquonlly, incioaso lho shaio of funos invosloo in inloiosl-Loaiing assols. As a iosull,
il is possiLlo lo inouco oach Lankoi lo pay a highoi ioluin on Lank liaLililios, Lonollling
lho consumois who uso lhoso liaLililios as a moans of paymonl. Mosl impoilanl, I show
lhal lhis oulcomo can Lo achiovoo in such a way lhal lho slaLilily of lho Lanking syslom is
piosoivoo (i.o., no Lank failuio occuis on lho oquiliLiium palh) oospilo lho implomonlalion
of fiaclional iosoivo Lanking. Spocilcally, I show lhal a joinl-liaLilily aiiangomonl of lho
kino oosciiLoo aLovo is an oloclivo mochanism lhal poimils lho r liansfoi of iosoivos
fiom liquio Lanks lo illiquio Lanks in oiooi lo onsuio lho solvoncy of oach inoivioual momLoi
Lank.
1ho iosl of lho papoi is sliucluioo as follows. Soclion 2 oiscussos lho iolaloo liloialuio.
Soclion 8 piosonls lho Lasic fiamowoik. Soclion 4 caiofully oosciiLos lho oxchango moch-
anism. In Soclion , I chaiacloiizo oquiliLiium allocalions in lho caso of a fully Lackoo
syslom. In Soclion 6, I oiscuss lho wolfaio implicalions of a joinl-liaLilily aiiangomonl.
Soclion 7 concluoos.
4
2. HELATED LITEHAT\HE
My analysis is cloaily iolaloo lo lho vasl liloialuio on insioo monoy. Somo piominonl
papois sluoying lho piopoilios of insioo monoy incluoo Kahn ano IoLoios (1008, 1000),
Cavalcanli ano Wallaco (1000a, 1000L), Williamson (1000), Azaiiaois, Lullaio, ano Smilh
(2001), Li (2001, 2006), Mailin ano Schiofl (2006), Loionlson (2006), Mills (2007), Ho,
Huang, ano Wiighl (2008), Anoolfallo ano Nosal (2000), Huangfu ano Sun (2011), Aiaujo
ano Minolli (2011), ano Gu, Mallosini, Monnol, ano Wiighl (foilhcoming), among many
olhois. In lhoso papois, iosoivo managomonl is nol lho focus of lho analysis, so lho wolfaio
piopoilios of alloinalivo iosoivo policios aio nol sluoioo.
Ono piominonl papoi lhal oxplicilly accounls foi iosoivo managomonl is Cavalcanli,
Liosa, ano 1omzolioos (1000).
2
In lhis papoi, lho aulhois chaiacloiizo an oquiliLiium
allocalion coiiosponoing lo a Lanking syslom foi which iogulalion is woakoi lhan 100/
iosoivo ioquiiomonls. In conliasl lo lhoii woik, my analysis focusos on lho wolfaio piopoi-
lios of inloiLank aiiangomonls as a moans of Lolloi managing Lanking iosoivos. Also, my
fiamowoik allows mo lo fully chaiacloiizo lho olocls on piicos ano quanlilios (as, in lhoii
moool, piicos aio oxogonous).
My iosulls can also Lo viowoo as a iosponso lo lho naiiow Lanking pioposal, as oo-
sciiLoo in Wallaco (1006). 1his aulhoi usos lho Diamono-DyLvig moool (soo Diamono ano
DyLvig, 1088) lo show lhal a Lanking syslom lhal issuos liaLililios fully Lackoo Ly safo
shoil-loim assols is socially unoosiiaLlo. In his concluoing iomaiks, Wallaco poinls oul
lhal, in ioalily, Lank liaLililios soivo as a moans of paymonl (somolhing nol capluioo in
lho Diamono-DyLvig fiamowoik) ano iaisos somo concoins aLoul how lhis piopoily woulo
inluonco lho conclusions. My analysis omphasizos piocisoly lho iolo lhal Lank liaLililios
play in facililaling liansaclions.
A ioconl papoi lhal also sluoios lho Lonolls of fiaclional iosoivo Lanking is Chaii ano
Iholan (2012). 1hoso aulhois lno lhal, unooi somo ciicumslancos, a fully Lackoo syslom
is socially oosiiaLlo Locauso of lho oxislonco of a social cosl (in loims of iosouicos oovoloo
2
Soo also Cavancanli, Liosa, ano 1omzolioos (200).

lo lho Lanking syslom) associaloo wilh lho piivalo cioalion of govoinmonl cuiioncy suLsli-
lulos. In my analysis, lho oosiiaLilily of a fiaclional iosoivo syslom iolios on lho oxislonco of
an inconlivo-foasiLlo inloiLank aiiangomonl lhal poimils momLoi Lanks lo liansfoi iosoivos
among lhomsolvos Lasoo on lhoii inoivioual liaoing hisloiios. In lhis iospocl, my analysis
is in lino wilh Kochoilakola (1008) ano Kochoilakola ano Wallaco (1008), who chaiacloiizo
lho olocls of oiloionl foims of iocoiokooping on liaoing aiiangomonls. In lho caso of a
fully Lackoo syslom, lhoio is no nooo foi any kino of ciooil aiiangomonl among Lanks, so
socioly ooos nol lako aovanlago of ils iocoio-kooping possiLililios. Unooi a fiaclional io-
soivo syslom, socioly Lonolls fiom a sophislicaloo ciooil aiiangomonl lhal poimils momLoi
Lanks lo oconomizo on non-inloiosl-Loaiing iosoivos ouo lo lho cioalion of long-loim ciooil
iolalionships. 1ho possiLilily of kooping liack of liaoing hisloiios wilhin lho Lanking socloi
is ossonlial foi lho implomonlalion of such an aiiangomonl.
In my fiamowoik, a koy assumplion foi liaclaLilily is lhal lho cloaiing ano solllomonl
of Lank liaLililios occui in a conlializoo localion, as in Kooppl, Monnol, 1omzolioos (2008)
ano Dovialov ano Wallaco (2000).
8
1ho assumplion lhal lho cloaiing ano solllomonl of
piivaloly issuoo liaLililios lako placo poiiooically in a conlializoo localion allows mo lo fully
chaiacloiizo lho olocls of alloinalivo iosoivo policios on oquiliLiium piicos ano quanlilios
ano, consoquonlly, focus on lho koy inconlivo pioLlom inluoncing lho oocision lo holo
iosoivos, namoly, hiooon aclion.
Finally, il is impoilanl lo monlion lhal my iosulls havo a similai lavoi lo lhoso oLlainoo
in Loionlson, Camoia, ano Walloi (2007) in lhal lho inlioouclion of an inloiLank aiiango-
monl of lho kino oosciiLoo aLovo allows socioly lo Lolloi allocalo iosouicos. In my analysis,
lho wolfaio gains como onliioly fiom Lolloi managomonl of Lanking iosoivos, which can only
Lo achiovoo lhiough lho implomonlalion of an inconlivo-foasiLlo schomo among lho momLois
of lho Lanking socloi.
8
In lhis iospocl, my moool Loais a iosomLlanco lo Lagos ano Wiighl (200) ano Iocholoau ano Wiighl
(200).
6
3. AODEL
1imo t = 0, 1, 2, ... is oisciolo, ano lho hoiizon is inlnilo. Lach poiioo is oiviooo inlo
lhioo suLpoiioos oi slagos. 1hoio aio lwo physical commooilios, iofoiioo lo as gooo r ano
gooo j, lhal aio poifoclly oivisiLlo. 1hoio aio lhioo lypos of agonls, inooxoo Ly i = 1, 2, 8,
who aio inlniloly livoo. 1hoio is a [0, 1[ conlinuum of oach lypo.
1ypos 2 ano 8 wanl lo consumo gooo r, whoioas lypo 1 wanls lo consumo gooo j. If
gooo r is nol piopoily sloioo in lho suLpoiioo il is piooucoo, il will oopiocialo complololy.
Gooo j is poiishaLlo ano cannol Lo sloioo, so il musl Lo consumoo in lho suLpoiioo il is
piooucoo. 1ypo 1 is aLlo lo pioouco gooo r only in lho lisl suLpoiioo. 1ypo 2 is aLlo lo
pioouco gooo j only in lho socono suLpoiioo. 1ypo 8 is unaLlo lo pioouco oilhoi gooo Lul
has accoss lo lho lochnology lo poifoclly sloio gooo r al any momonl. In lho lisl suLpoiioo,
oach lypo 8 also has accoss lo a (oivisiLlo) invoslmonl lochnology lhal ioquiios gooo r as
an inpul ano yiolos a lxoo ioluin j 1 (in loims of gooo r) only al lho Loginning of lho
following oalo. Finally, oach lypo 8 has accoss lo a lochnology lhal allows him lo cioalo, al
zoio cosl, an inoivisiLlo ano ouiaLlo oLjocl, iofoiioo lo as a nolo, lhal poifoclly ioonlilos
him. 1his moans lhal nolos issuoo Ly oach lypo 8 aio poifoclly oislinguishaLlo fiom lhoso
issuoo Ly olhoi pooplo so lhal counloifoiling will nol Lo a pioLlom.
I now oxplicilly oosciiLo piofoioncos. Lol r

0, 1 oonolo lypo 1`s pioouclion of gooo r

al oalo t, ano lol j

oonolo his consumplion of gooo j al oalo t. 1ypo 1`s piofoioncos

aio iopiosonloo Ly
n(j

) r

,
whoio

, ano n :

is conlinuously oiloionliaLlo, incioasing, ano sliiclly

concavo, wilh n(0) = 0 ano n

(0) = . Wo assumo lho pioouclion lochnology of gooo r

allows lypo 1 lo pioouco oilhoi zoio oi ono unil of gooo r al oach oalo, ovon lhough gooo
r is poifoclly oivisiLlo.
Lol j

oonolo lypo 2`s pioouclion of gooo j al oalo t, ano lol r

oonolo his
consumplion of gooo r al oalo t. 1ypo 2`s piofoioncos aio iopiosonloo Ly
(r

) .j

,
7
whoio .

, ano :

is conlinuously oiloionliaLlo, incioasing, ano concavo, wilh

(0) = 0. 1ypo 8 ooiivos ulilily r

if his consumplion of gooo r al oalo t is r

.
Finally, lol , (0, 1) oonolo lho common oiscounl facloi ovoi poiioos. I assumo j < ,

.
In oach suLpoiioo, lhoio is a oislincl iouno of inloiaclions. In lho lisl suLpoiioo, oach
lypo 1 is ianoomly malchoo wilh a lypo 8. In lho socono suLpoiioo, oach lypo 1 is ianoomly
malchoo wilh a lypo 2 wilh pioLaLilily ` (0, 1). In lho lhiio suLpoiioo, all lypo 2 ano
all lypo 8 mool in a conlializoo localion.
4. EXCHACE AECHAISA
1o oosciiLo lho oxchango piocoss, il is convonionl lo iofoi lo lypo 1 as a Luyoi, lo lypo 2
as a solloi, ano lo lypo 8 as a Lankoi. 1o Lolloi unooislano lhoso laLols, il is oasioi lo slail
wilh lho socono slago. In lhis slago, oach Luyoi is ianoomly malchoo wilh a solloi wilh
pioLaLilily `. Locauso lho Luyoi wanls gooo j Lul is unaLlo lo pioouco gooo r foi lho solloi
al lhal limo, lho paii will Lo aLlo lo liaoo only if a mooium of oxchango is maoo availaLlo.
As will Locomo cloai, oach Lankoi will Lo aLlo lo piovioo such a mooium of oxchango in
lho foim of poisonal liaLililios ioooomaLlo on oomano. I iofoi lo lhoso liaoaLlo liaLililios
as nolos. 1hus, lho oLjocls lhal a Luyoi ano a solloi liaoo aio gooo j ano nolos.
Lach Luyoi will Lo aLlo lo acquiio a nolo in lho lisl slago whon oach ono of lhom is
ianoomly malchoo wilh a Lankoi. In lhis slago, oach Luyoi has accoss lo lho lochnology lo
pioouco gooo r, so lho oLjocls a Luyoi ano a Lankoi liaoo aio gooo r ano nolos. Finally,
in lho lhiio slago, all sollois ano all Lankois inloiacl in a conlializoo localion. In lhis slago,
oach moichanl has an oppoilunily lo ioooom any nolo (i.o., convoiling a piivaloly issuoo
liaLilily inlo gooo r) ho has iocoivoo fiom a consumoi (if any) in lho piovious slago, so wo
can lhink of lhis slago as lho solllomonl slago. 1hus, lwo oLjocls can Lo liaooo: gooo r
ano nolos. Nolo lhal no pioouclion lakos placo ouiing lho solllomonl slago.
Lol mo now oosciiLo lho infoimalion sliucluio of lhis oconomy. Lach Lankoi is aLlo
lo oLsoivo lho aclions of olhoi Lankois in lho conlializoo localion. In lho lisl ano socono
slagos, lho Lilaloial liaoos aio piivaloly oLsoivaLlo, i.o., only lho paii of agonls pailicipaling
8
in lho mooling knows lho amounls liaooo.
Now I oxplain how oach Lankoi will Lo aLlo lo issuo piivalo liaLililios lhal ciiculalo as a
mooium of oxchango. 1hoio oxisls a cloaiinghouso associalion lhal is oosignoo lo cooioinalo
lho aclions of momLoi Lanks. Lach Lankoi can Lo a momLoi of lho cloaiinghouso al no cosl
Lul has lo follow ils iulos. 1ho cloaiinghouso ioquiios lhal oach Lankoi iopoils any mooling
in lho lisl slago in which a nolo has Loon issuoo, kooping liack of inoivioual issuanco of
nolos. Foi oach nolo issuoo, lho Lankoi is ioquiioo lo sloio a fiaclion of lho faco valuo of
lho nolo (in loims of gooo r), lo Lo inloipioloo as iosoivos Lacking lho issuanco of his nolo.
Any Lankoi who fails lo ioooom a nolo on oomano (in lho solllomonl slago) will havo
his momLoiship poimanonlly iovokoo (i.o., a Lankoi who ionogos on his piomisos will loso
his moniloiing piivilogos). Any Lankoi who fails lo iopoil lho issuanco of a nolo will also
poimanonlly loso his momLoiship. Nolo lhal his oovialion will Lo puLlicly oLsoivaLlo lo
lho momLois of lho cloaiinghouso only whon somoono piosonls such a nolo foi iooomplion
in lho solllomonl slago, which may lako sovoial poiioos lo happon.
I assumo lhal, onco a Lankoi has iopoiloo lho cioalion of a nolo ano has sol asioo lho
appiopiialo amounl of iosoivos, ho will n Lo aLlo lo acl oppoilunislically Ly suLsoquonlly
consuming lho amounl of gooo r ho has pioviously iopoiloo as iosoivos Lacking his liaLil-
ilios. 1ho only momonl in which lho Lankoi can oppoilunislically consumo any amounl
of gooo r ho has iocoivoo fiom somoono is Lofoio iopoiling lho cioalion of a nolo lo lho
cloaiinghouso. 1hus, I can say lhal oach Lankoi is ioquiioo lo ooposil" iosoivos wilh lho
cloaiinghouso associalion ovoiy limo ho announcos lho cioalion of a Lank liaLilily so lhal
ho cannol oppoilunislically accoss his iosoivos in fuluio poiioos. Iiocisoly, I assumo lhal,
afloi mooling wilh Luyois Lilaloially in lho lisl suLpoiioo, all Lankois gol logolhoi in lho
conlializoo localion lo ooposil iosoivos ano, poihaps, invosl in lho pioouclivo lochnology.
Iocall lhal lho pioouclivo lochnology ioquiios lhal a Lankoi invosl somo amounl of gooo
r in lho lisl suLpoiioo lo oLlain a ioluin in lho following poiioo. Nolo also lhal sollois
aiiivo al lho conlializoo localion only in lho lhiio suLpoiioo so lhal lhoy oo nol oLsoivo
lho amounls ooposiloo Ly oach Lankoi. Soo Figuio 1 foi a soquonco of ovonls wilhin oach
poiioo.
0
Il is impoilanl lo monlion lhal lho accoplaLilily of piivaloly issuoo nolos is onoogonously
ooloiminoo in lho moool. A solloi`s oocision lo accopl a nolo issuoo Ly a Lankoi in oxchango
foi his oulpul (gooo j) is Lasoo on lho availaLlo infoimalion ho has aLoul lho issuoi. In
my fiamowoik, lho availaLlo infoimalion foi oach solloi is lho iocoio of iooomplions foi
oach inoivioual Lankoi lhiough lho cloaiinghouso. 1hoio can Lo olhoi mochanisms lhal
poimil lho oloclivo ciiculalion of piivaloly issuoo nolos. In lhis papoi, I iosliicl allonlion
lo a mochanism lhal ioquiios momLoi Lanks lo iopoil lho cioalion of Lank liaLililios ano
ooposil iosoivos in oiooi lo ooal wilh lho inconlivo pioLloms.
Finally, I assumo lhal oach agonl can caiiy al mosl ono inoivisiLlo unil of monoy al
any momonl. 1his moans lhal inoivioual nolo holoings aio iosliicloo lo lho sol 0, 1. In
lhis iospocl, lho moool oovolopoo in lhis papoi iolalos lo lho socono gonoialion of soaich-
lhooiolic moools of monolaiy oxchango, following lho iooas in Shi (100) ano 1iojos ano
Wiighl (100). On lho olhoi hano, lhoio is n iosliiclion on lho numLoi of nolos lhal
oach Lankoi is allowoo lo issuo al any momonl oxcopl foi lhal imposoo Ly lho malching
lochnology. 1his moans lhal lho numLoi of nolos issuoo Ly any Lankoi Lolongs lo lho sol
0, 1, 2, ....
5. F\LLY HACKED SYSTEA
In lhis soclion, I chaiacloiizo an oquiliLiium allocalion in caso lho momLois of lho cloai-
inghouso oocioo nol lo ongago in any soil of ciooil oi insuianco schomo. 1hus, lo guaianloo
lho solvoncy of oach momLoi Lank, lho cloaiinghouso will ioquiio lhal oach Lankoi koops in
iosoivo lho full faco valuo of any nolo ho has issuoo. In olhoi woios, oach momLoi will havo
lo aoopl a 100/ iosoivo policy in oiooi lo iolain his momLoiship.
5.1. EquIIILrIun
1hioughoul lho papoi, I iosliicl allonlion lo oquiliLiia foi which lhoio oxisl an invaiianl
oisliiLulion of nolo holoings acioss Luyois, an invaiianl oisliiLulion of nolo holoings acioss
sollois, ano an invaiianl volumo of nolo cioalion ano nolo iooomplion Ly lho momLois of
10
lho Lanking socloi. 1hoso invaiianl oisliiLulions can Lo summaiizoo as follows. Lol :

oonolo lho invaiianl moasuio of Luyois holoing a nolo al lho ono of lho lisl slago, lol :

oonolo lho invaiianl moasuio of sollois holoing a nolo al lho ono of lho socono slago, ano lol
:

oonolo lho invaiianl volumo of nolos lhal aio ioliioo in lho lhiio slago. I only consiooi
oquiliLiia foi which :

= 1 ano :

= :

= `. 1hus, if oach Lankoi liulhfully iopoils

lho cioalion of Lank nolos, lhoio will Lo no uncoilainly wilh iospocl lo lho lolal volumo of
iooomplions in lho solllomonl slago.
Ono koy foaluio of lho moool lhal ionoois il highly liaclaLlo is lhal ono ooos nol nooo
lo koop liack of oach Lankoi`s inoivioual hisloiy of nolo cioalion ano nolo iooomplion. In
pailiculai, I iosliicl allonlion lo symmoliic oquiliLiia in which lho nolos issuoo Ly any
paii of Lankois will Lo lioaloo oqually acioss oiloionl malchos. 1hus, all lhal mallois
foi lho chaiacloiizalion of oquiliLiium is lho aggiogalo amounl of piivaloly issuoo nolos in
ciiculalion oulsioo lho Lanking socloi.
Lol mo slail Ly oosciiLing lho Lollman oqualions foi oach Luyoi. Lol \

oonolo lho
Loginning-of-poiioo oxpocloo oiscounloo ulilily of a Luyoi nol holoing a nolo, ano lol \

oonolo lho Loginning-of-poiioo oxpocloo oiscounloo ulilily of a Luyoi holoing a nolo. 1ho
Lollman oqualions foi a Luyoi aio givon Ly
\

= c`
_
n(j) ,\

(1 c`) ,\

, (1)
\

= c`
_
n(j) ,\

(1 c`) ,\

. (2)
Hoio j

oonolos lho quanlily of gooo j lhal ho will Lo aLlo lo puichaso fiom lho solloi
wilh whom ho is malchoo in oxchango foi a nolo, ano c [0, 1[ oonolos lho pioLaLilily lhal
lho solloi will accopl a piivaloly issuoo nolo in oxchango foi his oulpul.
If lho Luyoi slails lho poiioo wilhoul a nolo, lhon ho will Lo aLlo lo oLlain ono fiom
lho Lankoi wilh whom ho is cuiionlly malchoo, in which caso ho will pioouco ono unil of
gooo r. A nowly issuoo nolo cosls ono unil of gooo r ano is a piomiso lo pay c [0, 1[
unil of gooo r on oomano lo lho nolo holooi. 1hon, wilh pioLaLilily `, lho Luyoi will Lo
malchoo wilh a solloi in lho socono slago, in which caso lho Luyoi will Lo aLlo lo consumo
j

unils of gooo j wilh pioLaLilily c (ano will onloi lho following poiioo wilhoul a
11
nolo). Wilh pioLaLilily 1 c`, lho Luyoi will nol liaoo in lho socono slago ano will holo
on lo his nolo.
Lach Luyoi is aLlo lo savo in lho foim of liaLililios issuoo Ly Lankois (a sloio of valuo)
unlil ho has an oppoilunily lo consumo. Iocall lhal, Ly assumplion, oach Luyoi will nol Lo
aLlo lo pioouco again unlil ho has an oppoilunily lo spono his cuiionl nolo holoings. 1his
moans lhal lho Luyoi`s woallh is complololy ooloiminoo Ly lho oquiliLiium valuo of Lank
liaLililios.
Lol \

oonolo lho oxpocloo oiscounloo ulilily of a solloi who is cuiionlly malchoo wilh
a Luyoi nol holoing a nolo in lho socono slago, ano lol \

oonolo lho oxpocloo oiscounloo

ulilily of a solloi who is cuiionlly malchoo wilh a Luyoi holoing a nolo. In a slalionaiy
oquiliLiium, lho Lollman oqualions foi a solloi aio givon Ly
\

= ,
_
`\

(1 `) \

, (8)
\

= max

c[.j (c)[ ,
_
`\

(1 `) \

. (4)
I havo implicilly assumoo lhal lho Lankoi will volunlaiily ooposil lho faco valuo of oach nolo
issuoo so lhal Ly accopling a Lankoi`s nolo in liaoo a solloi iocoivos c. Lolow I caiofully
oiscuss lho inconlivo pioLlom.
Now consiooi lho Lollman oqualions foi oach Lankoi. Lol J

oonolo lho oxpocloo ois-

counloo ulilily of a Lankoi who is cuiionlly malchoo wilh a Luyoi nol holoing a nolo in lho
lisl slago, ano lol J

oonolo lho oxpocloo oiscounloo ulilily of a Lankoi who is cuiionlly

malchoo wilh a Luyoi holoing a nolo. Foi oach nolo issuoo in lho lisl slago, lho Lankoi
will Lo ioquiioo lo sol asioo lho amounl c [0, 1[ in oiooi lo mool his fuluio oLligalions.
In a slalionaiy oquiliLiium, lho Lollman oqualions foi a Lankoi aio givon Ly
J

= 1 c ,
_
`J

(1 `) J

, ()
J

= ,
_
`J

(1 `) J

. (6)
Nolo lhal a Lankoi who has issuoo a nolo (ano who has liulhfully iopoiloo il lo lho
cloaiinghouso) is aLlo lo immooialoly consumo lho amounl 1c of gooo r. 1ho consumplion
oocision is liivial: 1ho Lankoi will savo oxaclly lho ioquiioo amounl Locauso j < ,

.
12
As I havo pioviously monlionoo, lho oxpocloo oiscounloo ulilily of oach Lankoi ooos nol
oopono on lho numLoi of nolos ho has pioviously issuoo. On lho oquiliLiium palh, oach
Lankoi is willing lo ooposil wilh lho cloaiinghouso lho amounl c foi oach nolo issuoo so lhal
ho can immooialoly consumo 1c ovoiy limo ho issuos a nolo. Locauso lho cloaiinghouso will
onsuio lho solvoncy of oach inoivioual momLoi in lhis caso oi in any olhoi caso consiooioo in
lhis papoi, lho numLoi of nolos oulslanoing foi oach Lankoi will nol inluonco his pioLaLilily
of failuio. In pailiculai, lho pioLaLilily of failuio will Lo zoio Locauso lho cloaiinghouso
oilhoi ioquiios oach momLoi lo ooposil lho full faco valuo of oach nolo oi onsuios lho r
liansfoi of iosoivos fiom liquio Lanks lo illiquio Lanks.
A Lankoi who mools a Luyoi holoing a nolo can oloi his own nolo in oxchango foi lho
Luyoi`s nolo. In lhis caso, lho Lankoi can claim lho faco valuo of somoono olso`s nolo
only if ho iopoils lho acquisilion of such a nolo lo lho cloaiinghouso, in which caso lho
cloaiinghouso will ioquiio him lo holo iosoivos ouo lo lho issuanco of his own nolo. 1hus,
such a liaoo will Liing no oxlia Lonoll lo lho Lankoi unloss lho Luyoi givos him somo oxlia
amounl of gooo r logolhoi wilh his nolo. Lul, in lhis caso, lho Luyoi will cloaily Lo Lolloi
ol Ly holoing on lo his (pioviously acquiioo) nolo. 1hus, a swap of nolos happons if ano
only if Lolh agonls aio inoiloionl. Foi simplicily, I assumo lhal Lolh chooso nol lo swap
nolos in lhis caso.
4
1ho loims of liaoo in lho lisl ano socono slagos aio ooloiminoo as follows. Slail wilh
lho socono slago. I assumo lhal lho Luyoi makos a lako-il-oi-loavo-il oloi lo lho solloi, in
which caso ho will Lo aLlo lo capluio all suiplus fiom liaoo. Supposo lhal lho solloi accopls
piivaloly issuoo nolos wilh pioLaLilily ono, i.o., c = 1. (Lolow I oiscuss lho oocision lo
accopl nolos.) In a Lilaloial mooling, lho Luyoi`s suiplus fiom liaoo is givon Ly
n(j) ,\

,\

= n(j) ,,
4
Lvon if lhoy swappoo nolos, lho lolal volumo of iosoivos woulo iomain unchangoo Locauso lho iooomplion
of a nolo Ly anolhoi Lankoi simply moans a liansfoi of iosoivos wilhin lho Lanking syslom, which ooos nol
alocl lho lolal slock of nolos availaLlo lo lho nonLank puLlic.
18
ano lho solloi`s suiplus fiom liaoo is simply givon Ly
.j (c) .
1ho Luyoi is willing lo mako any oloi such lhal
n(j) , _ 0,
ano lho solloi accopls lho Luyoi`s oloi if ano only if
.j (c) _ 0.
1his pailicipalion consliainl will always Lino in lho caso in which lho Luyoi has all lho
Laigaining powoi, so lho quanlily of gooo j piooucoo in oach Lilaloial mooling will Lo givon
Ly
j = .

(c) . (7)
Consiooi now lho loims of liaoo in lho lisl slago. In a liaoo mooling, lho Luyoi`s
pailicipalion consliainl is givon Ly
`n
_
.

(c)
_
, (1 `)
_
\

_
_ 0.
Using (1) ano (2), wo can iowiilo lhis pailicipalion consliainl as follows:
n
_
.

(c)
_
_
[1 , (1 `)[
`
. (8)
1ho Lankoi`s pailicipalion consliainl is givon Ly
J

_ ,
_
`J

(1 `) J

,
which simply ioquiios
c _ 1. (0)
1his moans lhal an oquiliLiium valuo c musl salisfy Lolh (8) ano (0).
1o consliucl an oquiliLiium, wo havo lo koop in mino lhal oach Lankoi has lho oplion
of nol iopoiling his nowly issuoo nolo lo lho cloaiinghouso. 1ho punishmonl foi failing
14
lo iopoil any nowly issuoo nolo (ano solling asioo lho ioquiioo amounl of iosoivos) is lho
immooialo loiminalion of his momLoiship whon his oovialion is oolocloo. 1hus, oach Lankoi
liulhfully iopoils lho cioalion of a now nolo in lho lisl slago if ano only if
1 c ,
_
`J

(1 `) J

_ J

, (10)
whoio J

oonolos lho valuo associaloo wilh his Losl oovialion. 1ho lofl-hano sioo givos lho
Lankoi`s oxpocloo oiscounloo ulilily in caso ho choosos lo liulhfully iopoil lho cioalion of
a nolo. 1ho iighl-hano sioo givos his oxpocloo oiscounloo ulilily in caso ho aoopls his Losl
oovialion. 1his moans lhal oach Lankoi is willing lo ooposil wilh lho cloaiinghouso lho full
faco valuo of oach nolo ho has issuoo pioviooo lhal lho oquiliLiium valuo of Lank liaLililios
is such lhal his oxpocloo oiscounloo ulilily is al loasl lho samo as lhal ho woulo oLlain
Ly aoopling his Losl oovialion slialogy. His Losl oovialion slialogy may involvo issuing
somo nolos wilhoul holoing lho appiopiialo amounl of iosoivos, i.o., ongaging in fiaclional
iosoivo Lanking.
My lisl slop is lo show lhal lho valuo of oovialion is Lounooo Lolow Ly 1 ano is Lounooo
aLovo Ly (1 , `,)

_
1 (1 `)

,
_
, iogaioloss of lho ioquiioo ooposil amounl c. 1o
voiify lhal J

_ 1, nolico lhal a Lankoi who oocioos lo oovialo al any givon oalo is aLlo
lo immooialoly consumo ono unil of gooo r. His oocision lo nol ooposil iosoivos wilh lho
cloaiinghouso will coilainly alocl his conlinualion valuo. Lul, in any caso, his conlinualion
valuo is al loasl zoio. 1hus, I havo shown lhal J

_ 1. 1o show lhal J

has an uppoi
Louno, consiooi lho hypolholical caso in which a Lankoi who has oovialoo al somo oalo
t is aLlo lo oovialo al oach suLsoquonl oalo wilhoul incioasing his pioLaLilily of failuio
(foi inslanco, Locauso oach nolo holooi will fiooly oisposo of his nolos). In lhis caso, lho
maximum oxpocloo oiscounloo ulilily ho can oLlain is givon Ly

J = 1 , (1 `) J

,
whoio lho valuo J

salislos
J

= ` (1 `) ,J

.
Whon ho inilially oovialos al somo oalo t, ho is aLlo lo immooialoly consumo ono unil of
1
gooo r. Ho will Lo aLlo lo conlinuo liaoing only wilh pioLaLilily 1 `, which is piocisoly
lho pioLaLilily lhal lho Luyoi who has acquiioo his nolo ooos nol lno a liaoing pailnoi in
lho socono slago. If his oovialion is nol oolocloo al oalo t, ho will Lo aLlo lo issuo a now
nolo al oalo t 1 wilh pioLaLilily `. Afloi oalo t, his pioLaLilily of failuio will nol incioaso
(oospilo lho facl lhal moio lhan ono nolo has Loon issuoo wilhoul lho coiiosponoing amounl
of iosoivos) Locauso I havo assumoo lhal whoovoi acquiios his nolos afloi oalo t will fiooly
oisposo of lhom so lhal his pioLaLilily of suivival conlinuos lo Lo givon Ly 1 ` al lho ono
of oach oalo. Il is sliaighlfoiwaio lo show lhal

J =
1 (1 `)

,
1 (1 `) ,
.
1hus, lho valuo associaloo wilh his Losl oovialion J

is inoooo Lounooo:
1 _ J

_
1 (1 `)

,
1 (1 `) ,
. (11)
As I havo pioviously monlionoo, a Lankoi`s Losl oovialion slialogy may involvo issuing
somo nolos wilhoul holoing lho appiopiialo amounl of iosoivos, which will incioaso his
inoivioual pioLaLilily of failuio. 1o illuslialo lhis poinl, consiooi a oovialion slialogy (nol
nocossaiily his Losl oovialion) in which a Lankoi oocioos lo issuo nolos wilhoul holoing
iosoivos. If ho choosos nol lo iopoil a nowly issuoo nolo, ho can immooialoly consumo lho
amounl of gooo r ho has iocoivoo in oxchango foi his nolo. Wilh pioLaLilily 1 `, his
oovialion will iomain unoolocloo, in which caso ho will Lo aLlo lo issuo a now nolo in lho
following poiioo wilh pioLaLilily `. Wilh pioLaLilily (1 `)

, his oovialion will iomain

unoolocloo in lho following poiioo (now lwo of his nolos aio in ciiculalion), in which caso ho
will Lo aLlo lo issuo a lhiio nolo in lho suLsoquonl poiioo wilh pioLaLilily `. Nolo lhal his
pioLaLilily of failuio incioasos ovoi limo. As long as his oovialion iomains unoolocloo, ho
will Lo aLlo lo conlinuo lo issuo nolos wilhoul iopoiling lhoii oxislonco lo lho cloaiinghouso,
immooialoly consuming lho piocooos fiom lho salo of lhoso nolos. 1ho oxpocloo oiscounloo
ulilily associaloo wilh lhis oovialion slialogy is givon Ly

J = 1 (1 `) ,

J

,
16
whoio, foi oach i = 1, 2, 8, ..., wo havo

= `
_
1 (1 `)

,

J

_
(1 `) (1 `)

,

J

.
1his slialogy is likoly lo Lo his Losl oovialion slialogy whon ` is iolalivoly low, which
moans lhal his oofoclion will Lo oolocloo only wilh a small pioLaLilily, ano lho oiscounl
facloi , is low. Lvon lhough a Lankoi`s Losl oovialion slialogy may nol Lo uniquo, lhoio
oxisls a uniquo valuo J

in lho inloival givon Ly (11) lhal coiiosponos lo lho maximum

valuo associaloo wilh a Losl oovialion slialogy.
1o guaianloo lhal oach Lankoi volunlaiily pailicipalos in lho cloaiinghouso, il is nocos-
saiy lo mako momLoiship sumcionlly piollaLlo such lhal his oxpocloo oiscounloo ulilily
is laigoi lhan lhal associaloo wilh his Losl oovialion. 1ho liulh-lolling consliainl (10)
guaianloos lhal oach inoivioual Lankoi holos onough iosoivos lo pay lho full faco valuo of
oach oulslanoing nolo. 1hus, il is inoivioually ialional foi oach solloi lo chooso c = 1
(i.o., lo accopl piivaloly issuoo nolos wilh pioLaLilily ono) pioviooo lhal (10) is salisloo.
Iocall lhal lho solloi oLsoivos lho faco valuo c associaloo wilh a nolo ano lho iocoio of
pasl iooomplions Ly oach inoivioual Lankoi lhiough lho cloaiinghouso. Whon lho valuo c
is such lhal (10) is salisloo, oach solloi knows lhal lho momLois of lho cloaiinghouso aio
willing lo ooposil lho ioquiioo amounl of iosoivos foi oach nolo issuoo. 1hus, ho is willing
lo accopl a nolo issuoo Ly a momLoi Lank wilh pioLaLilily ono.
In oquiliLiium, I ioquiio lhal (10) holos wilh oqualily, which will allow mo lo oLlain lho
highosl oquiliLiium valuo of Lank liaLililios consislonl wilh liulhful iopoiling. In soclion
6, I piovioo an inloipiolalion foi lhis pailiculai choico ano oiscuss lho implicalions of
alloinalivo iogimos.
Finally, nolo lhal lho pailicipalion consliainls (8) ano (0) imposo Lolh a minimum ano
a maximum valuo of nolos consislonl wilh oquiliLiium:

_
.n

_
[1 , (1 `)[
`
__
_ c _ 1. (12)
1ho minimum valuo aiisos ouo lo lho Luyoi`s pailicipalion consliainl, whoioas lho maximum
valuo aiisos ouo lo lho Lankoi`s pailicipalion consliainl. Givon lhoso ioquiiomonls, il is
now sliaighlfoiwaio lo foimally oolno a slalionaiy oquiliLiium.
17
DehnItIon 1 n.nn:j nnn:j j&.|.h:.&n J: h nnj J:.hJ nh . nn
n::nj
_
J

, J

, J

, \

, \

, \

, \

, c, j, c, :

, :

, :

_
n.Jj.nj :

= 1, :

= :

= `,
c = 1, ;1), ;.), ;), ;), ;), ;), ;7), ;1u) &.h j&n|.j, nnJ ;1.). 1n nJJ..n, J

.
h n|& n.nJ &.h n hnn|:` h J.n.n :njj &hn nh hnn|: . :j&.:J
J. &.h h |n:.njh& h nn&n c, n.njn n h :n.n J n n.
Nolo lhal I havo nol incluooo in lho oolnilion aLovo lho oisliiLulion of oulslanoing nolos
acioss lho populalion of Lankois.

As I havo pioviously monlionoo, all lhal mallois foi lho

ooloiminalion of an oquiliLiium allocalion is lho aggiogalo amounl of piivaloly issuoo nolos
in ciiculalion oulsioo lho Lanking socloi.
In a slalionaiy oquiliLiium, al oach oalo, a fiaclion ` of Lankois issuo a nolo in lho lisl
slago, so lho lolal volumo of iosoivos incioasos Ly lho amounl `c (in loims of gooo r).
In lho lhiio slago, a fiaclion ` of all oulslanoing nolos is ioliioo, so lho lolal volumo of
iosoivos oocioasos Ly `c. 1his moans lhal lho lolal volumo of iosoivos al lho ono of lho
poiioo is oxaclly lho samo as lho volumo al lho Loginning of lho poiioo in lho caso of a
slalionaiy oquiliLiium.
AssuntIon 1 Assumo ,

_
.n

()
_
.
Unooi lhis assumplion, I can foimally show lho oxislonco ano uniquonoss of a slalionaiy
oquiliLiium.
IroosItIon 2 1:.JJ hn . . &.n|j nn||, h: r. n &n.j& n.nn:j nn-
n:j j&.|.h:.&n .n &h.h h n|& J n . j.n hj

c =
1 , (1 `) (1 ,) J

1 , (1 `)
. (18)
1n h. j&.|.h:.&n, h nJ-J-:.J r :: n: j.n hj (1 `)

c n nh Jn.

Foimally, I can oolno

as lho moasuio of Lankois who havo oulslanoing nolos al lho

ono of lho lisl slago ano

as lho moasuio of Lankois who havo oulslanoing nolos al lho

ono of lho lhiio slago. Il musl Lo lho caso lhal

ano

.
18
IrooI. ComLining () wilh (10), wo oLlain
J

= J

. (14)
Using (6) ano (14), wo lno
J

=
`,J

1 , (1 `)
. (1)
Ioplacing (14) ano (1) inlo (), wo oLlain lho valuo

c shown in (18), which is lho uniquo
solulion. 1ho amounl of gooo j piooucoo ano liaooo in oach Lilaloial mooling in lho socono
slago is givon Ly
j = j = .

c
_
.
Using (1) ano (2), wo oLlain lho valuos \

ano \

:
\

=
`[n( j) ,[
1 ,
,
\

=
`[n( j) ,[
1 ,
.
Locauso of lho assumplion lhal lho Luyoi has all Laigaining powoi whon liaoing wilh a
solloi, il follows lhal \

= \

= 0.
Now wo nooo lo voiify wholhoi

c salislos (12). Unooi Assumplion 1, il is sliaighlfoiwaio
lo show lhal

c salislos (12) pioviooo lhal . is sumcionlly small (i.o., oach solloi is sumcionlly
pioouclivo).
Finally, I nooo lo show lhal lho ono-of-poiioo oxcoss iosoivos aio (1 `)

c. Fiisl, nolo
lhal, al lho ono of oach oalo, all sollois who havo acquiioo a nolo aio aLlo lo convoil il inlo

c unil of gooo r. Nolo also lhal lhoio is no ioason foi lhom lo oolay lho iooomplion of
a nolo. Locauso :

= 1 in a slalionaiy oquiliLiium ano nolo holoings aio consliainoo lo

lho sol 0, 1, lho lolal volumo of iosoivos al lho ono of lho lisl slago musl Lo

c. Locauso
:

= `, lho lolal volumo of iosoivos oocioasos Ly lho amounl `

c al lho ono of lho lhiio

slago. 1his moans lhal lho ono-of-poiioo volumo of oxcoss iosoivos is (1 `)

c.
In a slalionaiy oquiliLiium, oach Lankoi consumos 1

c unil of gooo r whon ho has an

oppoilunily lo issuo a nolo, oach Luyoi consumos .

c
_
unils of gooo j whon ho has an
10
oppoilunily lo liaoo wilh a solloi ano piooucos ono unil of gooo r whon ho acquiios a nolo,
ano oach solloi piooucos .

c
_
unils of gooo j ano consumos

c unil of gooo r whon ho
has an oppoilunily lo liaoo wilh a Luyoi.
Nolo lhal a souno Lanking syslom of lho kino oosciiLoo in lhis soclion cosls somolhing foi
nonLanks. As I havo shown, lho oquiliLiium valuo

c is ooloiminoo in such a way lhal oach
Lankoi oLlains a low of incomo ooiivoo fiom lho nolo-issuing piivilogos lhal is sumcionl
lo inouco him lo ooposil iosoivos lo fully Lack his oomanoaLlo liaLililios. As a iosull,
no Lankoi invosls in lho pioouclivo lochnology in lho caso of a fully Lackoo syslom. 1ho
ioquiiomonl of ooposiling lho full faco valuo of oach nolo wilh lho cloaiinghouso in lho
foim of non-inloiosl-Loaiing assols (sloiago) is imposoo lo guaianloo lho solvoncy of oach
inoivioual Lankoi. Whon oach inoivioual Lankoi follows lhis policy, lho Lanking syslom as
a wholo holos oxcoss iosoivos al lho ono of oach poiioo. In lho noxl soclion, I consiooi an
inslilulional aiiangomonl lhal allows lho momLois of lho Lanking syslom lo invosl al loasl
somo of lhoii funos in lho pioouclivo lochnology ano lhal guaianloos lho solvoncy of oach
inoivioual Lankoi. 1hus, such an aiiangomonl will piomolo omcioncy wilhoul compiomising
slaLilily.
6. FHACTIOAL HESEHYE SYSTEA
1ho goal of lhis soclion is lo chaiacloiizo an inconlivo-foasiLlo aiiangomonl wilhin lho
Lanking socloi lhal piosoivos lho slaLilily of lho Lanking syslom Lul poimils lho momLois
of socioly lo achiovo a Lolloi allocalion of iosouicos Ly laking aovanlago of moio piollaLlo
invoslmonl oppoilunilios. Supposo now lhal, al lho Loginning of oalo zoio, lho momLois
of lho cloaiinghouso associalion agioo lo issuo nolos lhal aio oloclivoly joinl oLligalions of
ils momLois. Lach Lankoi conlinuos lo issuo nolos lhal ioonlify him as a ooLloi, Lul lho
cloaiinghouso puLlicly announcos lhal, in lho ovonl lhal an inoivioual Lankoi is unaLlo lo
ioooom his own nolos, olhoi momLois will honoi any oLligalion of such a momLoi, accoioing
lo lhoii joinl capacily. Unooi lhis aiiangomonl, oach Lankoi is onlilloo lo uso olhoi Lankois`
iosoivos lo mool his own oLligalions in caso ho is calloo foi iooomplion pioviooo lhal ho is
20
willing lo ploogo his own iosoivos lo ioooom lho nolos issuoo Ly olhoi Lankois in caso lhoy
nooo lhom.
1ho cloaiinghouso is iosponsiLlo foi supoivising lho ioquiioo ooposil amounls Ly lho
momLois of lho coalilion. Whon ooaling wilh oach inoivioual momLoi, lho cloaiinghouso
nooos lo inouco him lo liulhfully iopoil lho issuanco of nolos ano volunlaiily ooposil lho
appiopiialo amounl of iosouicos, which is lho samo as saying lhal il nooos lo onsuio lhal lho
liulh-lolling consliainl (10) is salisloo. 1ho cloaiinghouso will also ooloimino lho amounls
lo Lo invosloo in sloiago ano in lho pioouclivo lochnology, which will foim lho poilfolio
of lho coalilion. Inilially, oach inoivioual Lankoi has an oqual claim on lho cuiionl ano
fuluio assols of lho Lank coalilion. Howovoi, ooponoing on his inoivioual hisloiy of nolo
cioalion ano nolo iooomplion, lho Lankoi may Lo a ciooiloi oi a ooLloi wilhin lho coalilion,
in which caso his claim on lho cuiionl ano fuluio assols of lho coalilion may incioaso oi
oocioaso ovoi limo.
1ho main oiloionco fiom lho piovious caso is lhal now lho iolovanl moasuio lo ooloimino
lho solvoncy of oach Lankoi who is calloo foi iooomplion al oach oalo is lho ialio of lho valuo
of n|| iosoivos of lho coalilion lo lho valuo of n|| nolos lhal aio piosonloo foi iooomplion.
Locauso lho momLois of lho coalilion know lhal nol all oulslanoing nolos will Lo piosonloo
foi iooomplion al oach oalo, il is possiLlo lo invosl al loasl somo fiaclion of lho funos in
lho pioouclivo lochnology lo oLlain a highoi ialo of ioluin pioviooo lhal oach momLoi is
willing lo ooposil lho appiopiialo amounl of iosouicos wilh lho cloaiinghouso, which moans
lhal ho is willing lo ongago in a joinl-liaLilily aiiangomonl.
6.1. EquIIILrIun
Supposo lhal oach Luyoi slails oalo zoio wilhoul any nolo. 1hus, al oalo zoio, oach
Lankoi has an oppoilunily lo issuo a nolo lo lho Luyoi wilh whom ho is inilially malchoo.
Supposo inilially lho cloaiinghouso ooloiminos lhal oach Lankoi is ioquiioo lo savo lho
samo amounl (lo Lo ooposiloo wilh lho cloaiinghouso) as lhal oLsoivoo in lho piovious
caso (i.o., lho amounl

c) so lhal (10) conlinuos lo holo wilh oqualily. 1his moans lhal lho
21
lolal amounl of gooo r lhal all Lankois sol asioo al oalo zoio is givon Ly

c. Supposo lhal
lho aggiogalo amounl invosloo in lho pioouclivo lochnology al oalo zoio ano al any olhoi
suLsoquonl oalo is givon Ly
(1 `)

c
j
. (16)
Unooi lhis invoslmonl policy, lho amounl of gooo r lhal will Lo availaLlo foi lho momLois of
lho cloaiinghouso al lho Loginning of oach oalo t _ 1 is al loasl (1 `)

c. Givon lhal, afloi
oalo zoio, lho aggiogalo amounl of gooo r lhal all Lankois sol asioo is givon Ly `

c, lho lolal
amounl of gooo r availaLlo foi invosling in oilhoi lho sloiago lochnology oi lho pioouclivo
lochnology is givon Ly

c al oach oalo. Locauso a fiaclion ` of all nolos in ciiculalion will Lo
ioliioo in lho solllomonl slago, lhis moans lhal lho oquiliLiium valuo of nolos is now givon
Ly
c

=

c
`
_
1
1 `
j
_
(17)
in caso lho cloaiinghouso follows lho invoslmonl policy oosciiLoo aLovo. 1ho oquiliLiium
valuo (17) is ooloiminoo Ly aggiogalo foasiLilily in caso lho momLois of lho cloaiinghouso
agioo lo ongago in lho joinl-liaLilily aiiangomonl oosciiLoo aLovo, ano lho cloaiinghouso
follows lho policy of invosling lho amounl (16) in lho pioouclivo lochnology al oach oalo.
1his moans lhal lho consumplion of oach Luyoi who lnos a liaoing pailnoi will Lo givon
Ly
j = .

_
c

_
.
Locauso c

c, oach Luyoi is sliiclly Lolloi ol whon lho momLois of lho cloaiinghouso
oocioo lo implomonl a Lanking aiiangomonl of lho kino oosciiLoo aLovo. Locauso oach
Lankoi iomains inoiloionl, lhis aiiangomonl is inconlivo compaliLlo. Locauso oach solloi
also iomains inoiloionl, I can concluoo lhal lho slalionaiy allocalion oLlainoo in lhis caso
Iaiolo oominalos lho slalionaiy allocalion oLlainoo in lho caso of a fully Lackoo syslom. I
summaiizo lhoso lnoings in lho following pioposilion.
IroosItIon 3 1:.JJ hn . . &.n|j nn||, h: r. n n.nn:j nnn:j
j&.|.h:.&n .n &h.h h n|& J n . j.n hj c

c. 1n h. j&.|.h:.&n, nh hnn|:
22
n.J h nn&n

c &hn h hn nn :&n.j .& n n. Jh. j&.|.h:.&n 1n:
Jn.nn h n.nn:j nnn:j j&.|.h:.&n hn.nJ &nJ: n J&||j hn|J jn.
Nolo lhal, Lofoio solllomonl, lho ialio of lho aggiogalo valuo of iosoivos (sloiago) lo lho
aggiogalo valuo of Lank liaLililios is givon Ly
`c

= ` < 1.
1his moans lhal lho Lanking syslom as a wholo is holoing in iosoivo only a fiaclion of
lho aggiogalo valuo of Lank liaLililios. 1ho momLois of lho cloaiinghouso know lhal nol
all nolos in ciiculalion will Lo piosonloo foi iooomplion al lho ono of oach oalo, so Ly
cioaling a mochanism foi pooling iosoivos lo avoio inoivioual insolvoncy, il is possiLlo lo
ioouco lho amounl of non-inloiosl-Loaiing assols in lho syslom ano, consoquonlly, incioaso
lho amounl of inloiosl-Loaiing assols holo Ly lho coalilion. 1his onhancoo managomonl of
iosoivos allows lho Lanking syslom lo pay a highoi ioluin on Lank liaLililios. Nolo lhal lho
Lanking syslom as a wholo always has onough iosoivos lo ioliio all nolos lhal aio piosonloo
foi iooomplion al lho ono of oach oalo, so il is complololy solvonl Ly consliuclion. Lach
inoivioual Lankoi may nol havo onough iosoivos lo ioliio his own nolos al a pailiculai oalo
Lul is aLlo lo uso olhoi Lankois` iosoivos lo fullll his piomisos.
In lho caso oosciiLoo aLovo, oach Lankoi iomainoo inoiloionl Lolwoon aoopling a joinl-
liaLilily schomo ano opoialing unooi a fully Lackoo syslom, which implioo lhal all wolfaio
gains wonl onliioly lo Luyois. 1his iolios on lho choico of a pailiculai liaoing mochanism
lhal ioquiios lho liulh-lolling consliainl lo holo wilh oqualily al oach oalo. Alloinalivoly,
I can consliucl an oquiliLiium in which all wolfaio gains go onliioly lo Lankois. In lhis
caso, lho oquiliLiium valuo of nolos conlinuos lo Lo givon Ly

c so lhal oach Luyoi iomains
inoiloionl. 1his moans lhal, givon lho policy of invosling lho amounl (16) in lho pioouclivo
lochnology al oach oalo, oach Lankoi now nooos lo sol asioo lho amounl
c

=

c`
_
1
1 `
j
_

28
whon ho has an oppoilunily lo issuo a nolo. 1his moans lhal, whon ho is aLlo lo issuo a
nolo, ho immooialoly consumos lho amounl
1

c`
_
1
1 `
j
_

.
Locauso c

<

c, lho lofl-hano sioo of lho liulh-lolling consliainl (10) is highoi. Locauso
lho valuo associaloo wilh a Lankoi`s Losl oovialion ooponos on lho amounl oach Lankoi is
ioquiioo lo ooposil wilh lho cloaiinghouso whon ho issuos a nolo, J

may vaiy wilh changos

in lho loims of liaoo. In lhis caso, il is cloai lhal J

has lo oilhoi oocioaso oi iomain lho

samo Locauso oach Lankoi is ioquiioo lo sol asioo a smalloi amounl. 1hus, (10) conlinuos
lo Lo salisloo. Lach Lankoi is sliiclly Lolloi ol whon lho loims of liaoo aio such lhal ho
is aLlo lo capluio all wolfaio gains fiom lho aooplion of a fiaclional iosoivo syslom of lho
kino oosciiLoo aLovo.
IroosItIon 4 1:.JJ hn . . &.n|j nn||, h: r. n n.nn:j nnn:j
j&.|.h:.&n .n &h.h h n|& J n . j.n hj

c. 1n h. j&.|.h:.&n, nh hnn|:
n.J h nn&n c

<

c &hn h hn nn :&n.j .& n n. Jh. j&.|.h:.&n
1n: Jn.nn h n.nn:j nnn:j j&.|.h:.&n hn.nJ &nJ: n J&||j hn|J jn.
Nolo lhal, in lhis caso, oach Lankoi sliiclly piofois lo Lo a momLoi of a cloaiinghouso
associalion lhal inilially agioos lo issuo liaLililios lhal aio joinl oLligalions of ils momLois
ano follows lho invoslmonl policy oosciiLoo aLovo, which ionoois lho schomo inconlivo com-
paliLlo. Nol only is lho joinl-liaLilily aiiangomonl oosciiLoo aLovo an oloclivo mochanism
lo onsuio lho solvoncy of oach inoivioual Lankoi, Lul il also makos lho consliuclion of a
highoi-yioloing poilfolio foi lho Lank coalilion foasiLlo. Ly piovioing a mochanism lhal
poimils momLoi Lanks lhal aio calloo foi iooomplion lo uso lho iosoivos of Lanks lhal havo
iolo Lalancos, a joinl-liaLilily aiiangomonl makos il possiLlo lo invosl somo of lho aggiogalo
iosouicos of lho coalilion in lho pioouclivo lochnology, incioasing lho ioluin oLlainoo on
Lanking assols.
Il is impoilanl lo monlion onco again lhal lho slaLilily of lho syslom (i.o., lho facl lhal
lhoio is no Lank failuio in oquiliLiium) can only Lo achiovoo Ly piomising a sumcionlly high
24
oxpocloo oiscounloo ulilily lo oach Lankoi, which is nocossaiy lo inouco him lo liulhfully
iopoil lho cioalion of Lank liaLililios ano volunlaiily ooposil iosoivos wilh lho cloaiinghouso.
1his moans lhal lhoio oxisls an onoogonously ooloiminoo uppoi Louno on lho ioluin oach
Lankoi is willing lo pay on his liaLililios (i.o., lho slaLilily of lho Lanking syslom cosls
somolhing foi nonLanks). 1ho facl lhal Lankois ongago in a joinl-liaLilily aiiangomonl of
lho kino oosciiLoo aLovo poimils us lo iaiso lhis uppoi Louno ouo lo a moio omcionl uso
of inloiLank ooposils.
6.2. DIscussIon
Il is impoilanl lo piovioo somo inloipiolalions of lho kino of oxchango mochanism I havo
oosciiLoo in lhis papoi. Il is possiLlo lo inloipiol lho cloaiinghouso in my moool as lho kino
of piivalo Lank coalilion lhal was foimoo in lho Uniloo Slalos piioi lo lho oslaLlishmonl of
lho Foooial Iosoivo Syslom. Foi inslanco, Goilon (1084, 108) ano Goilon ano Mullinoaux
(1087) havo pioviooo ovioonco lhal lho cloaiinghouso associalions lhal woio foimoo in
somo cilios in lho Uniloo Slalos (o.g., Now Yoik, Loslon, ano Chicago) in lho socono half
of lho 10lh conluiy ovolvoo inlo a coalilion of Lanks lhal ioquiioo oach momLoi Lank lo
iopoil ils liansaclions, imposoo iosoivo ioquiiomonls on oach momLoi Lank, ano supoivisoo
lho solllomonl piocoss on a oaily Lasis. In lhis caso, lho aooplion of a fiaclional iosoivo
syslom can Lo inloipioloo as a mochanism lo inouco coopoialion wilhin lho momLois of
lho cloaiinghouso so lhal lho syslom as wholo can ioouco lho shaio of funos invosloo in
non-inloiosl-Loaiing iosoivos ano, consoquonlly, incioaso lho shaio of funos invosloo in
inloiosl-Loaiing assols.
Unooi lhis inloipiolalion, lho kino of inloiLank aiiangomonl oosciiLoo in lho piovious
soclion iosomLlos lho issuanco of loan coililcalos Ly lho momLois of lho cloaiinghouso, which
was ono of lho main lnancial innovalions of cloaiinghouso associalions. 1hoso coililcalos
woio issuoo Ly momLoi Lanks lo solllo liansaclions wilh olhoi momLois of lho cloaiinghouso
as pail of lho nolo-cloaiing piocoss, in which caso lho cloaiinghouso associalion ioquiioo
lho ooposil of a coilain class of assols lo socuio lho cioalion of loan coililcalos. 1ho
2
main implicalion of lhis kino of lnancial innovalion was lho ioouclion in non-inloiosl-
Loaiing iosoivos (such as golo) lhal momLoi Lanks hao lo holo in oiooi lo solllo inloiLank
liansaclions. In my fiamowoik, I can say lhal a Lankoi who ooos nol havo onough iosoivos
lo ioliio his nolos al any oalo is allowoo lo Loiiow fiom olhoi Lankois Ly issuing a loan
coililcalo, which will guaianloo lho full convoiliLilily of his nolos. Lach inoivioual Lankoi
will Lo onlilloo lo issuo loan coililcalos pioviooo lhal, whon ho happons lo holo oxcoss
iosoivos, ho is also willing lo ploogo his own iosoivos lo olhoi Lankois who nooo iosoivos lo
pay nolo holoois.
Lofoio I concluoo, il is impoilanl lo oiscuss lho wolfaio piopoilios of al loasl anolhoi
oLvious monolaiy aiiangomonl: An oquiliLiium in which all liaoos aio caiiioo oul wilh
oulsioo lal monoy. In lho Apponoix, I show lhal lho slalionaiy allocalion unooi a fully
Lackoo syslom can also Lo implomonloo wilh lal monoy (in lho aLsonco of a cloaiinghouso),
Lul lho slalionaiy allocalion unooi a fiaclional iosoivo syslom cannol Lo iopiooucoo in an
oconomy whoio lal monoy is lho only availaLlo mooium of oxchango. 1his iosull aiisos
Locauso lho aooplion of a fiaclional iosoivo syslom involvos a iolalivoly sophislicaloo in-
loiLank aiiangomonl lhal cannol Lo implomonloo wilh lal monoy. 1his is in lino wilh
lho iosulls in Kochoilakola (1008), who aiguos lhal lal monoy woiks as an .n:J foim
of momoiy in lho sonso lhal lho sol of allocalions lhal can Lo implomonloo wilh momoiy
(i.o., poifocl knowloogo of liaoing hisloiios) is laigoi lhan lho sol of allocalions lhal can Lo
implomonloo wilh lal monoy.
7. COCL\SIO
1his papoi has omphasizoo lho wolfaio piopoilios of a spocilc lypo of Lank coalilion:
a joinl-liaLilily aiiangomonl. As opposoo lo maikols, lhis foim of Lank coalilion involvos
lho moniloiing of lho aclivilios of momLoi Lanks. I havo shown lhal lhis foim of Lanking
oiganizalion olois an oloclivo iosponso lo a woll-known lonsion Lolwoon lho Lonolls of
fiaclional iosoivo Lanking ano lho iisks associaloo wilh il. In pailiculai, I havo oomon-
slialoo lhal il is possiLlo lo allow momLoi Lanks lo lako aovanlago of piollaLlo (long-loim)
26
invoslmonl oppoilunilios wilhoul compiomising lho slaLilily of lho Lanking syslom. 1ho
Lank coalilion oosciiLoo aLovo onsuios lho liansfoi of iosoivos fiom moio liquio Lanks lo
illiquio Lanks oospilo lho oxislonco of inconlivo pioLloms. As a iosull, il is possiLlo lo
incioaso lho shaio of funos invosloo in inloiosl-Loaiing assols, iaising lho ialo of ioluin oL-
lainoo on Lanking assols. 1ho way lo achiovo lhis goal wilhoul compiomising lho slaLilily
of lho Lanking syslom is lo onsuio lhal lho valuo allachoo lo pailicipalion in lho Lank coali-
lion is sumcionlly high so lhal oach momLoi Lank volunlaiily holos lho ioquiioo amounl
of iosoivos. 1hus, a joinl-liaLilily aiiangomonl of lho kino oosciiLoo aLovo is a wolfaio-
impioving mochanism lhal allows lho momLois of socioly lo achiovo a Lolloi allocalion of
iosouicos (a liuly supoiioi foim of Lanking).
Finally, il is impoilanl lo monlion lhal lho moool oovolopoo in lhis papoi can Lo oasily
applioo lo lho sluoy of olhoi issuos in lho lolo of monoy ano Lanking. Foi inslanco, Sanchos
(2018) inliooucos an aggiogalo shock lhal alocls lho ioluin lo sloiago lo sluoy lho olocls
of an oxloinal shock lo lho valuo of Lanking assols on liaoing aclivily unooi alloinalivo
Lanking aiiangomonls.
HEFEHECES
[1[ D. Anoolfallo, L. Nosal.Monoy, inloimooialion, ano Lanking,"J&:nn| J `nn:j 1-
nn. 6 (2000), pp. 280-204.
[2[ L. Aiaujo, I. Minolli. On lho ossonlialily of Lanks," 1n:nn.nn| 1nn. 1.& 2
(2011), pp. 670-601.
[8[ C. Azaiiaois, J. Lullaio, L. Smilh.Iiivalo ano puLlic ciiculaling liaLililios,"J&:nn| J
1nn. Jh:j 00 (2001), pp. 0-116.
[4[ A. Loionlson. On lho piivalo piovision of lal cuiioncy," 1&:nn 1nn. 1.& 0
(2006), pp. 1688-1608.
[[ A. Loionlson, G. Camoia, C. Walloi. Monoy, ciooil ano Lanking," J&:nn| J 1nn.
Jh:j 18 (2007), pp. 171-10.
27
[6[ I. Cavalcanli, A. Liosa, 1. 1omzolioos.Iiivalo monoy ano iosoivo managomonl in a
ianoom-malching moool,"J&:nn| J 1|..n| 1nnj 107 (1000), pp. 020-04.
[7[ I. Cavalcanli, A. Liosa, 1. 1omzolioos. Liquioily, monoy cioalion ano oosliuclion, ano
lho ioluins lo Lanking," 1n:nn.nn| 1nn. 1.& 46 (200), pp. 67-706.
[8[ I. Cavalcanli, N. Wallaco.A moool of piivalo Lank-nolo issuo,"1.& J 1nn. 1j-
nnn. 2 (1000a), pp. 104-186.
[0[ I. Cavalcanli, N. Wallaco.Insioo ano oulsioo monoy as alloinalivo mooia of ox-
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`nn:j 1nn. 6 (2000), pp. 288-288.
[12[ D. Diamono, I. DyLvig. Lank iuns, ooposil insuianco, ano liquioily," J&:nn| J 1|..n|
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(100).
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Foooial Iosoivo Lank of Ihilaoolphia, Januaiy-FoLiuaiy (1084), pp. 1-11.
[16[ G. Goilon. Cloaiinghousos ano lho oiigins of conlial Lanking in lho Uniloo Slalos," J&:nn|
J 1nn. 1.:j 4 (108), pp. 277-288.
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ano lho 10lh conluiy commoicial Lank cloaiinghouso," J&:nn| J `nj, :J. nnJ
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28
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401.
AIIEDIX
Hoio I show lhal lho slalionaiy allocalion oLlainoo unooi a fully Lackoo syslom can Lo
iopiooucoo in caso oulsioo lal monoy is lho only availaLlo mooium of oxchango, whoioas
lho slalionaiy allocalion oLlainoo unooi a fiaclional iosoivo syslom cannol.
Supposo I inilially onoow oach lypo 8 ano a (ianoom) moasuio 1 ` of lypo 1 wilh
ono unil of a ouiaLlo, inoivisiLlo, ano inliinsically usoloss oLjocl calloo lal monoy. 1hus,
80
lho lolal slock of monoy is givon Ly 2 `. I wanl lo show lhal lhoio oxisls a slalionaiy
monolaiy oquiliLiium lhal implomonls lho samo allocalion as lhal oLlainoo unooi a fully
Lackoo syslom. In lhis oquiliLiium, lho valuo of monoy is ono in lho lisl maikol, .

c
_
in lho socono, ano

c in lho lhiio.
In a slalionaiy monolaiy oquiliLiium, lhoio oxisls an invaiianl oisliiLulion of monoy
holoings acioss oiloionl lypos of agonls. Lol :

oonolo lho invaiianl moasuio of lypo 1

holoing ono unil of monoy al lho ono of lho lisl maikol, lol :

oonolo lho invaiianl moasuio

of lypo 2 holoing ono unil of monoy al lho ono of lho socono maikol, ano lol :

oonolo lho
invaiianl moasuio of lypo 8 holoing ono unil of monoy al lho ono of lho lhiio maikol. In
pailiculai, I consiooi lho following oisliiLulion: :

= :

= 1 ano :

= `. 1his implios
lhal, in lho lisl slago, a liaoo mooling occuis whon a lypo 8 lnos a lypo 1 nol holoing
monoy, in which caso lho foimoi givos lho lalloi ono unil of monoy in oxchango foi ono unil
of gooo r, ano lhal, in lho socono slago, a liaoo mooling occuis whon a lypo 1 lnos a lypo
2, in which caso lho lalloi piooucos .

c
_
unils of gooo j in oxchango foi ono unil of
monoy. In lho lhiio slago, lhoio is a Waliasian maikol in which all lypo 2 who liaooo in lho
piovious slago supply monoy ano all lypo 8 who liaooo in lho lisl slago oomano monoy.
1ho oquiliLiium valuo of monoy in lhis maikol will Lo

c.
Il is sliaighlfoiwaio lo show lhal such an oquiliLiium oxisls if ano only if
1

c
`,
_
1

c
_
1 ,
_ 1. (18)
1his conoilion guaianloos lhal, afloi liaoing in lho lisl maikol, oach lypo 8 lnos il oplimal
lo sloio lho amounl

c of gooo r in oiooi lo soll il on lho lhiio maikol in oxchango foi ono
unil of monoy. Nolo also lhal a lypo 8 holoing monoy in lho lhiio maikol coulo oxchango
his nolo foi

c unil of gooo r. In lhis caso, his Losl oovialion woulo Lo lo immooialoly
consumo il. Howovoi, conoilion (18) also guaianloos lhal ho will Lo Lolloi ol Ly holoing
on lo his nolo.
In lhis oquiliLiium, nolo lhal oach lypo 8 acls as a cuiioncy liaooi" in lho sonso lhal
ho Luys ano solls cuiioncy on a iogulai Lasis, making a pioll fiom lhoso aclivilios.
Finally, lo show lhal lho slalionaiy oquiliLiium allocalion in lho caso of a fiaclional
81
iosoivo syslom cannol Lo implomonloo wilh lal monoy, il is sumcionl lo oxamino lho
Luogol consliainl of oach inoivioual Lankoi (lypo 8). In lho caso of a fiaclional iosoivo
syslom, I havo shown lhal il is possiLlo lo koop oach Lankoi`s consumplion unchangoo ano,
simullanoously, incioaso lho valuo of piivaloly issuoo nolos. 1his is possiLlo Locauso lho
liansfoi schomo aooploo in lho conlializoo localion allows lho cloaiinghouso lo aggiogalo"
lho inoivioual Luogol consliainls, iooucing lho amounl of oxcoss iosoivos in lho syslom. In
lho caso of lal monoy, oach Lankoi has lo savo lho full amounl in oiooi lo Luy Lack ono
unil of lal monoy in lho lhiio slago, so lhal ho can conlinuo liaoing in fuluio poiioos.
1hus, lhoio is no aggiogalion of inoivioual Luogol consliainls. 1hoiofoio, lho allocalion
oLlainoo unooi a fiaclional iosoivo syslom cannol Lo iopiooucoo in caso lal monoy is lho
only availaLlo mooium of oxchango.
82
Bilateral
meetings
between banker
and buyer
All bankers
move to the
centralized
location
until the end
of the
period
Bilateral
meetings
between buyer
and seller
All sellers
move to the
centralized
location
Stage 1
Stage 2
Stage 3
Figure 1: Sequence of Events Within a Period