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Bank runs, deposit insurance, and liquidity

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  • Douglas W. Diamond
  • Philip H. Dybvig

Abstract

This article develops a model which 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. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.

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Bibliographic Info

Article provided by Federal Reserve Bank of Minneapolis in its journal Quarterly Review.

Volume (Year): (2000)
Issue (Month): Win ()
Pages: 14-23

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Handle: RePEc:fip:fedmqr:y:2000:i:win:p:14-23:n:v.24no.1

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Related research

Keywords: Deposit insurance ; Liquidity (Economics);

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References

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  1. Dybvig, Philip H. & Spatt, Chester S., 1983. "Adoption externalities as public goods," Journal of Public Economics, Elsevier, vol. 20(2), pages 231-247, March.
  2. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
  3. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
  4. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  5. Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
  6. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
  7. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," The Journal of Business, University of Chicago Press, vol. 51(3), pages 413-38, July.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Reflections on a Year of Crisis
    by Barry Ritholtz in the big picture on 2009-08-21 14:30:12
  2. De Pablo, cuasimonedas y Hayek: una aclaracion
    by Nicolas Cachanosky in Punto de Vista Economico on 2012-05-21 03:10:24
  3. Financial Crises
    by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2012-10-19 19:09:00
  4. Lacker and Bernanke
    by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2013-02-17 22:25:00
  5. Preventing bank runs – a primer
    by ? in Bruegel blog on 2013-04-02 10:58:20
  6. Selgin on Gorton
    by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2013-07-12 18:12:00
  7. The Financial Crisis in Retrospect
    by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2014-02-23 22:52:00
  8. Bank Assets and Bank Runs
    by Jonathan Finegold in Economic Thought on 2014-02-26 19:57:43
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