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Liquidity, Banks, and Markets

Douglas W. Diamond
Journal of Political Economy
Vol. 105, No. 5 (October 1997), pp. 928-956
DOI: 10.1086/262099
Stable URL: http://www.jstor.org/stable/10.1086/262099
Page Count: 29
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Liquidity, Banks, and Markets
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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.

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