THE ECONOMICS OF SECURITY DIVISIBILITY AND FINANCIAL INTERMEDIATION.

In this paper we have shown that a necessary condition for the existence of financial intermediaries is the existence of imperfect divisibility of primary securities. In turn, a necessary condition for imperfect divisibility is the presence of transactions costs broadly conceived. Under such conditions, there is no unambiguous measure of the risk of an asset since that risk must be measured relative to a specific portfolio. But with imperfect divisibility, attainable portfolios vary with an investor's scale of wealth. Our purpose, however, has not been to demonstrate that by relaxing the assumptions of the conventional model, we can get different conclusions. That would be a rather empty exercise. Rather, we have tried to show that just as the theory of perfect competition is useful as a benchmark in the analysis of industrial organization, so the conventional model can be used as the starting point for an analysis of the implications of real world 'imperfections.' [ABSTRACT FROM AUTHOR]