An Incentive Problem in the Dynamic Theory of Banking
AbstractThis paper develops a continuous-time model of liquidity provision by banks, in which customers can deposit and withdraw their funds strategically. The strategic withdrawal option introduces an incentive-compatibility problem that turns the problem of designing deposit contracts into a non-standard, non-convex optimal control problem. The paper develops a solution method for this problem and shows that, in this more general frame-work, the insights obtained from the traditional banking models change considerably, up to the point of liquidity provision becoming impossible. The continuous-time framework allows to discuss the problem elegantly and may help to make this part of the banking literature more operational in the sense of modern asset pricing theory.
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Bibliographic InfoPaper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp25.
Date of creation: Dec 2000
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Liquidity; deposit contracts; banking; incentive compatibility; continuous time; dynamic programming;
Other versions of this item:
- von Thadden, Ernst-Ludwig, 2002. "An incentive problem in the dynamic theory of banking," Journal of Mathematical Economics, Elsevier, vol. 38(1-2), pages 271-292, September.
- D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
- D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
- G20 - Financial Economics - - Financial Institutions and Services - - - General
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
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