Pdf government deposit insurance and the diamonddybvig. The second chapter presents a generalized version of the diamonddybvig model. Lin reveal what s behind the diamond and dybvig models results i. Diamond and dybvig classis theorc y probability 1 p, a trade becomer impatients typ 0e and value dats 0e consumptio onlyn here. Dybvig bank runs deposi, insurancet an,d liquidity liquidity of assets. Government deposit insurance and the diamonddybvig model. Diamond dybvig 1983 model i the diamond dybvig 1983 model is a celebrated contribution that. Dybvig yale university this paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to. Bank runs, deposit insurance, and liquidity request pdf.
However, because of the availability of free storage, we may set c2. This article is reprinted from the journal of political economy june 1983, vol. Pdf this article develops a model which shows that bank deposit. Diamond and dybvig 1983 in this view the answers to the two questions depends on equilibrium selection. Diamond and dybvigs classic theory of financial intermediation. The diamonddybvig model provides an example of an economic game with more than one nash equilibrium, where it is logical for individual depositors to engage in a bank run once they suspect one might start, even though that run will cause the bank to collapse. The bank and its borrowers are subject to limited liability. Banking and deposit insurance as a risktransfer mechanism. This is so even in the presence of the sequential service. In a version of the model that posits bertrand competition among banks, there are sequential equilibria that imply positive profits.
This article gives the first explicit analysis of the deman fod r liquidit any d th e transformatio n service provided by banks. In diamond and dybvig 1983, suspension is costly because it interferes with agents welfaremaximizing consumption plans. For example, the classical paper of diamond and dybvig 1983 dd shows that the government deposit insurance can prevent an economy from lapsing into a bad bank run equilibrium by assuming all. As in diamonddybvig 1983, the desired amount of liquidity is increasing in the degree of risk aversion, because investors are willing to give up some longterm return to avoid losses from liquidating assets.
The central bank or government may be able to ensure a. Lecture 8 diamong dybvig model diamond dybvig model. In many economic environments, however, price changes additionally impact the agents by altering other constraints agents face. Bank runs, deposit insurance, and liquidity, the journal of political economy, 9, 401. Pdf this article uses narrative and numerical examples to exposit the ideas in diamond and dybvig 1983 and some recent extensions of their.
The model is variation of diamond and dybvig 1983 and postlewaite and vives 1987 with multiple banks. Bryant 1980, diamond and dybvig 1983, and jacklin 1987 show that demand deposit contracts enable individuals effectively to share uninsurable liquidity risk. Bank runs, deposit insurance, and liquidityjournal of political economy 91. Investors face privately observed risks which lead to a demand for liquidity. Bank runs and the suspension of deposit convertibility merwan engineer unrwrsrv of guelph, guelph, 0n1 canadu nig 7 wi received september 1988, final version received may 1989 in a longerhorizon version of diamond and dybvigs 1983 model, suspending convertibrhty of. The obvious thing to do is for some securityholders to monitor on behalf of others, and we are then faced with analysing the provision of incentives for delegated monitoring. Pdf bank runs, deposit insurance, and liquidity researchgate. This article uses narrative and numerical examples to exposit the ideas in diamond and dybvig 1983 and some recent extensions of their model. Iiipyij this paper sholvs that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Exposits the bene ts of the liquidity transformation that nancial intermediaries do 3. Contrary to the view put forward by diamond and dybvig, governmentprovided deposit insurance is not free. There are many methods by which delegated monitoring might be. Consider an economy with entrepreneurs and potential. A theory of liquidity and regulation of financial intermediation.
Points out the perils of liquidity transformation susceptibility to runs 4. Bank runs and the suspension of deposit convertibility. Within the framework of diamonddybvig 1983, the optimal run free outcome is shown to be the unique forward induction equilibrium. We add an explicit replicator dynamic from evolutionary game theory to provide for a sensitivity analysis that encompasses both models. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Pecuniary externalities, segregated exchanges, and market. An introduction to the diamonddybvig model 1983 core. However, the zeroprofit contract is supported as the unique equilibrium outcome if the agents beliefs are. This is a feature that our model shares with diamond 1997, who introduces an asset market with limited participation into the diamonddybvig model and shows that banking coexists with mar. If marginal utility at zero is low enough, then goldstein and pauzner 2005s claim about the optimality of the diamond and dybvig 1983 contract is true. Here a modified version of the diamonddybvig model is used to show how suspension may have only minor welfare costs so long as bank debt is transactable and can serve as a medium of exchange. Diamond and dybvig 1983 develops a model to explain why.
Dybvig yale university this paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. I show, under intuitive conditions on the riskaverse utility function, the nonoptimality of the diamond and dybvig 1983 contract in the goldstein and pauzner 2005 environment. View notes lecture 8 diamong dybvig model from econ 3232 at northwestern university. Governmentprovided deposit insurance in practice differs significantly from that proposed in theory. Optimal bank regulation in the presence of credit and runrisk. Dybvig, 1983, bank runs, deposit insurance, and liquidity, journal. This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. According to them, liquidity needs of individuals are unobservable to the market and, hence, cannot be insured in a normal manner. Bank runs, deposit insurance, and liquidity douglas w. Diamond and dybvig 1983 argue that an important function of banks is to create liquidity, that is, to offer deposits that are more liquid than the assets that they hold. Kevin dowd is one of the worlds leading researchers on free banking and he also has a new book out about the financial crisis. Section iv criticises the diamonddybvig model and concludes the paper. Both of these approaches are essentially nondynamic.
The following six features summarize the prevalent view by many observers. Dybvig journal of political economy, 1983 presented by. Diamond dybvig model 1983 there is a basic problem of bank structure. A freeentry banking equilibrium is characterized by banks offering a contract. First, the fdic must expend real resources administering and operating the deposit insurance fund. It can be shown that a consumer trades only a riskfree security e. Policy issues also come down to equilibrium selection. Bryant 1980 and diamond and dybvig 1983 have provided us with the classic benchmark model for a bank run. An introduction to the diamonddybvig model 1983 by j. The apparent banking market failure modeled by diamond and dybvig 1983 rests on. Diamonddybvig 1983 provide a model of intermediation in which bank runs are.
Diamonddybvig model in which no liquid investments occur in equilibrium. Note however that the market equilibrium ensures an allocation that is strictly worse than thesociallyoptimalallocation. The model shows how banks mix of illiquid assets such as business or mortgage loans and liquid liabilities deposits which may be withdrawn at any time may give rise to selffulfilling panics among depositors. The model in diamond and dybvig 1983 incorporates important features of the. The diamonddybvig model is an influential model of bank runs and related financial crises. The basic twononcooperativeequilibriumpoint model of diamond and dybvig is considered along with the work of morris and shin utilizing the possibility of outside noise to select a unique equilibrium point. Investors who have a demand for liquidity will prefer to invest via a bank, rather than hold assets directly. What drives the possibility of a run in the model is demand for liquidity that is, a desire on the part of savers to be able to retrieve their funds at any time. Dybvig published 1983 bank runs are a common feature of the extreme crises.
Ii the link between liquidity creation and the bank run equilibrium in the diamonddybvig model the world of diamond and dybvig 1983 is characterised by three periods t0,1,2, tw0 types of consumers and a single homogenous good see. The recent literature on bank runs, following diamond and dybvig 1983, studies the banking sector in isolation from the greater economy. Diamond and dybvig develop a model where there is a demand for assets that resemble traditional. Iiipyij this paper sholvs that bank deposit contracts can provide allocations. Check to see if you are eligible for free downloads.
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