DP19405 Achieving Safety: Personal, Private and Public Provision
We study how a primary need for minimum safety affects investment choices. In addition to risky projects, agents may choose to invest in personal assets they can control. Investing in personal assets serves as self-insurance, as they ensure a higher minimum return but offer a lower expected return than the risky project offers. In autarky, investors can achieve safety only via self-insurance and costly liquidation of the project. Private intermediaries can reduce inefficient self-insurance by offering safe debt backed by self-insured investors holding equity and can resolve the underlying risk conflict by demandable debt. Public debt crowds out the private supply of safe assets, lowering the safe rate and aggregate investment. In contrast, deposit insurance can either decrease or increase the private supply of safe assets, as well as the safe rate and aggregate investment. Our approach explains the vast and inelastic demand for safe assets, which are hard to explain by standard preferences at times of minimal rates.
