Intermediaries as Safety Providers

Authors: Toni Ahnert (Bank of Canada and Finance Theory Group) and Enrico Perotti (University of Amsterdam and CEPR)

Title: Intermediaries as Safety Providers

Abstract: Preferences for safety can explain the stable portfolio share of safe assets that is hard to explain with transaction needs or liquidity insurance. We propose a model of investor preferences around a reference point and heterogeneous self-insurance options. Intermediaries carve safe claims out of risky investment backed by enough loss-absorbing claims. While delegation of risk choices creates a conflict among investors, intermediaries can resolve it by issuing safe demandable debt, since the option to withdraw upon demand implements a safe payoff in all states. As safety needs increase, intermediaries expand the supply of safe claims, leading to more investment and liquidation in risky states. When competition is imperfect or the risk-absorption capacity is low, the safety premium also increases.