Inefficient liquidity provision

We prove that in competitive market economies with no insurance for idiosyncratic risks, agents will always overinvest in illiquid long-term assets and underinvest in short-term liquid assets. We take as our setting the seminal model of Diamond and Dybvig (J Polit Econ 91(3):401–419, 1983), who first posed the question in a tractable model. We reach such a simple conclusion under mild conditions because we stick to the basic competitive market framework, avoiding the banks and intermediaries that Diamond and Dybvig (1983) and others introduced.