Burton Hollifield, Ariel Zetlin-Jones - November 13, 2017
We study risk and maturity transformation when bank liabilities facilitate trade in goods markets and households face aggregate liquidity shocks. Banks' balance sheets transform aggregate investment risk providing a stable source of liquidity to households. When investments are sufficiently risky, bank liabilities transform risk and maturity: liabilities are less risky and have shorter term payoffs than banks' real investments. When maturity transformation is socially efficient, aggregate long-term liquidity is scarce raising the relative price of long-term bank issuances. In the competitive equilibrium banks provide too little maturity transformation relative to the social optimum.