Financial Intermediation in an Overlapping Generations Model with Transaction Costs

We analyze an overlapping generations economy where agents interact to share liquidity risk. We show that a pure exchange economy has excessive trade in equilibrium, and that intergenerational financial intermediaries reduce the number of interactions by catering to clienteles with uncorrelated liquidity needs. In the intermediated economy equilibrium, intermediaries finance redemptions with loan income, and never sell assets. If the economy is subject to transaction costs, the intermediated economy can sustain higher stationary investment and welfare. We also find that transactions costs cause the yield curve to be downward sloping, and that the non-intermediated economy is inherently cyclical.