Asset price risk, banks and markets

This paper examines the role of Diamond-Dybvig banks when financial markets exist. Previous studies have shown that banks are redundant when financial markets are available. This paper shows that is not true when the asset price risk is considered. Asset price risk makes the liquidation value of the assets uncertain. Therefore holding the asset directly is risky for the consumers who are subject to liquidity shocks. Banks can provide a deterministic return to the depositors since the aggregate withdrawal is predictable and therefore the banks do not have to liquidate the asset in the market.