In general, there are two ways of financing, direct finance and indirect finance. In direct finance, households directly purchase the securities issued by firms through securities market. Thus, households have to judge and absorb firm¡¦s credit risks directly. On the other hand, in indirect finance, firm¡¦s credit risks are judged and absorbed by financial intermediaries who mediate funds collected from households to firms. Both financing methods play an important role in whole economic activities.
Simply speaking, there are four main players involved in financing activities. Each player has different specific functions that related to the others, financing activities would not be able to be held if one of them were not exist. The Arrow-Debreu General Equilibrium model in direct/indirect finance explains the functions of each player, and the relationship between them as shown below.
Arrow-Debreu General Equilibrium Model
Bf + Bb = Bh
Firms Households Assets Liabilities Assets Liabilities Investment I
Securities Bh Deposits D+
Assets Liabilities Loans L+
Households are fund provider to other finance player, no matter under which financing way (direct or indirect finance) the fund is provided. From the disposable income that they get, households will allocate some for consumption. The portion that has not been consumed called saving. Then the...
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