ON THE THEORY OF FINANCIAL INTERMEDIATION

This paper surveys the theory of financial intermediation and argues that innovations are changing the demand for services of intermediaries. It concludes that intermediation is being fundamentally transformed. After identifying ten elemental risks in finance, the paper reviews how instruments (contracts), agencies, and the government affect portfolio choice. It analyzes financial institutions, assets, and markets and argues that derivative securities and technical innovations are eroding the traditional market niches of intermediaries. In the new markets, they are in danger of losing market share. Data from the United States suggest that such a decline is in progress.