Three deposit insurance schemes are studied in a version of the diamond dybvig banking model with a risky technology. View notes lecture 8 diamong dybvig model from econ 3232 at northwestern university. That is, it matters to the issuer of an asset that the. Professor todd keister rutgers university may 2017 b anking and f inancial f ragility a baseline model. Section iv criticises the diamond dybvig model and concludes the paper. May 26, 2015 a literature pioneered by bryant 1980 and diamond and dybvig 1983 emerged in the 1980s examining bank liquidity services and stability. Carlos hernandez, nicole schmit, eric schulman 2 topic overview economic role of banks. Policy issues also come down to equilibrium selection. We would like to show you a description here but the site wont allow us. Banks create demand deposits to provide investors with liquid assets.
Pdf sequential decisions in the diamonddybvig banking. Points out the perils of liquidity transformation susceptibility to runs 4. Information revelation in the diamonddybvig banking model. The common ingredients are a nite number of agents. The diamonddybvig model of banking journal of political economy, 1983 is amended by introducing communication barriersthese being implicit in their model and in most explanations of why people hold socalled liquid assets. The apparent banking market failure modeled by diamond and dybvig 1983 rests on their inconsistently applying their sequential servicing constraint to private banks but not to their government deposit insurance agency. Sequential equilibrium and competition in a diamonddybvig. Lecture 8 diamong dybvig model diamond dybvig model1983. 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. Cavalcanti t his article argues that the model in diamond and dybvig 1983, dd hereafter. Exposits the bene ts of the liquidity transformation that nancial intermediaries do 3.
Bypassing a host of important but, for the present purposes, secondary details the note assumes that the initial effects of financial innovation and crash can be summarized by a parameter that determines the liquidity or moneyness of land or capital. Diamond and dybvig classis theorc y probability 1 p, a trade becomer impatients typ 0e and value dats 0e consumptio onlyn here. Pdf government deposit insurance and the diamonddybvig. This cited by count includes citations to the following articles in scholar. Diamond and dybvig 1983 develops a model to explain why. Miller distinguished service professor of finance at the university of chicago booth school of business. The diamonddybvig model is an influential model of bank runs and related financial crises. He specializes in the study of financial intermediaries, financial crises, and liquidity. Diamond dybvig model 1983 there is a basic problem of bank structure.
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. 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. An introduction to the diamonddybvig model 1983 jan j. The article shows that in a finitetrader version of the diamond and dybvig model 1983, the ex ante efficient allocation can be implemented as a unique equilibrium. Government deposit insurance and the diamonddybvig model.
Diamond and dybvig discuss this constraint informally, but do not. The central bank or government may be able to ensure a. Tilburg university an introduction to the diamonddybvig. In contrast, we have only three traders, and individuallevel randomness implies that our model always has aggregate uncertainty. Dybvig journal of political economy, 1983 presented by. 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. This is so even in the presence of the sequential service constraint, as emphasized by wallace 1988, whereby the bank must solve a sequence of maximization problems as. In a longerhorizon version of diamond and dybvig s 1983 model, suspending convertibility of bank deposits into cash does. On the nonoptimality of a diamonddybvig contract in the. Bank liquidity and stability in an overlapping generations model. Section 2, we provide a brief overview of the scheme lan guage this. Fiiffinnnr i introduction the present paper provides a nontechnical introduction to diamond and dybvigs 1983 model.
Ii the link between liquidity creation and the bank run equilibrium in the diamond dybvig model 1he world of diamond and dybvig 1983 is characterised by three periods t0,1,2, two types of consumers and a single homogenous good see. Bank runs, deposit insurance, and liquidity ideasrepec. Financial crises eco 575 part ii finance department. 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. The ones marked may be different from the article in the profile. This article uses narrative and numerical examples to exposit the ideas in diamond and dybvig 1983 and some recent extensions of. In a nutshell, it models fractionalreserve banks as intermediaries transforming illiquid assets into liquid liabilities and depicts the relationship among depositors as a. Diamond and dybvig 1983 in this view the answers to the two questions depends on equilibrium selection. Bank runs and the suspension of deposit convertibility. Bank runs, deposit insurance, and liquidity douglas w.
All agents are endowed with one unit of a storable homogeneous good in period t 0. Sequential decisions in the diamonddybvig banking model. Information revelation in the diamonddybvig banking model ed nosal and neil wallace september 22, 2009 1 introduction green and lin 4 gl, peck and shell 7 ps, and andolfatto et al 1 anw explore optima in similar, but not identical versions of the diamonddybvig 2 dd model. However, it has not been easy to show that the direct mechanism which has the best norunequilibrium also has a runequilibrium in settings where the bank can commit to a mechanism. If intermediaries provide asset services, they provide services to borrowers who issue assets to them. Diamond and dybvig 1983 develop a model to explain why banks choose to issue deposits that are more liquid than their assets and to understand why banks. Bryant, 1980 allen,1981 diamond, dybvig, 1983 boot, greenbaum, thakor, 1993 holmstrom, tirole, 1998. Although there may be interactions between these types of service, this article focuses only on asset services. A simple exposition of the diamonddybvig model federal. The journal of political economy, volume 91, issue 3 jun. This article argues that the model in diamond and dybvig 1983, dd hereafter was a significant conceptual and methodological advance in studying banking. Introduction to the special issue on the diamonddybvig model. Diamond and dybvig model a onegeneration economy in which agents face private preference shocks and technologies exhibit productive illiquidity.
Diamond dybvig 1983 model i the diamonddybvig 1983model is a celebrated contribution that. Diamonddybvig 1983 provide a model of intermediation in which bank runs are driven by pessimistic depositor expectations. 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. Optimal diamonddybvig mechanism in large economies with. Pdf government deposit insurance and the diamonddybvig model. Another aspect of our model differs from diamond and dybvigs. Deposit insurance and regulation in a diamonddybvig banking. Dec 09, 2012 this article uses narrative and numerical examples to exposit the ideas in diamond and dybvig 1983 and some recent extensions of their model. Moral hazard in the diamonddybvig model of banking munich. Another aspect of our model differs from diamond and dybvig s. Without this inconsistency, banks can provide optimal risksharing without taxbased deposit insurance, even when the number of type 1 agents is stochastic, by. We study the diamonddybvig model of financial intermediation jpe, 1983 under the assumption that depositors have information about previous decisions. The schemes include a full deposit guarantee and two alternatives which people have suggested as ways to limit the moral hazard problem of deposit insurance. Diamond and dybvigs model is extended to four periods t 0, 1,2,3 by including an asset which matures in period 3 and also a third type of investor who most wants to consume in period 3.
This special issue of the economic quarterly is dedicated to the 1983 model of bank runs developed by douglas diamond and philip. Our discussion of transformation services is based on diamond and dybvig 1983. At least since diamond and dybvig 1983 hereafter dd, bankruns have been thought of as arising from multiple equilibria. The diamond dybvig bank run model major ingredients of the diamond dybvig model 1 agents.
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