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Adverse selection and competing deposit insurance systems in pre-depression Texas

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  • Jeffery W. Gunther
  • Linda M. Hooks
  • Kenneth J. Robinson

Abstract

In 1910, Texas instituted a highly unique deposit insurance program for its state chartered banks consisting of two separate plans: the depositors guaranty fund, similar in operation to the deposit insurance schemes adopted in several other states; and the depositors bond security system, which required the procurement of a privately issued insurance policy. We hypothesize that the provision of a choice in funds led to risk-sorting among the banks, with the relatively conservative institutions opting for the comparatively rigorous bond security system. Employing a probit model with heteroskedasticity, the evidence we obtain from balance sheet data recorded at the time the banks were required to enlist in an insurance plan indicates that such was the case, as the alternative plan relying on privately issued insurance was widely unpopular except among relatively conservative and well-managed institutions.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Dallas in its series Financial Industry Studies Working Paper with number 97-4.

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Date of creation: 1997
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Handle: RePEc:fip:feddfi:97-4

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Keywords: Deposit insurance;

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  1. Davidson, Russell & MacKinnon, James G., 1984. "Convenient specification tests for logit and probit models," Journal of Econometrics, Elsevier, vol. 25(3), pages 241-262, July.
  2. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-60, August.
  3. Rebel A. Cole & Jeffery W. Gunther, 1993. "Separating the likelihood and timing of bank failure," Financial Industry Studies Working Paper 93-2, Federal Reserve Bank of Dallas.
  4. Merton, Robert C, 1978. "On the Cost of Deposit Insurance When There Are Surveillance Costs," The Journal of Business, University of Chicago Press, vol. 51(3), pages 439-52, July.
  5. Osterberg, William P. & Thomson, James B., 1991. "The effect of subordinated debt and surety bonds on the cost of capital for banks and the value of federal deposit insurance," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 939-953, September.
  6. Gorton, Gary, 1996. "Reputation Formation in Early Bank Note Markets," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 346-97, April.
  7. O'Higgins, Niall, 1994. "YTS, Employment, and Sample Selection Bias," Oxford Economic Papers, Oxford University Press, vol. 46(4), pages 605-28, October.
  8. Wheelock, David C & Kumbhakar, Subal C, 1995. "Which Banks Choose Deposit Insurance? Evidence of Adverse Selection and Moral Hazard in a Voluntary Insurance System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 186-201, February.
  9. Edward J. Kane, 1987. "No Room for Weak Links in the Chain of Deposit Insurance Reform," NBER Working Papers 2317, National Bureau of Economic Research, Inc.
  10. Thomson, James B, 1987. "The Use of Market Information in Pricing Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(4), pages 528-37, November.
  11. Charles W. Calomiris, 1989. "Deposit insurance: lessons from the record," Economic Perspectives, Federal Reserve Bank of Chicago, issue May, pages 10-30.
  12. Dwyer, Gerald Jr. & Hasan, Iftekhar, 2007. "Suspension of payments, bank failures, and the nonbank public's losses," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 565-580, March.
  13. Knapp, Laura Greene & Seaks, Terry G, 1992. "An Analysis of the Probability of Default on Federally Guaranteed Student Loans," The Review of Economics and Statistics, MIT Press, vol. 74(3), pages 404-11, August.
  14. Yatchew, Adonis & Griliches, Zvi, 1985. "Specification Error in Probit Models," The Review of Economics and Statistics, MIT Press, vol. 67(1), pages 134-39, February.
  15. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
  16. Godfrey,L. G., 1991. "Misspecification Tests in Econometrics," Cambridge Books, Cambridge University Press, number 9780521424592, October.
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Cited by:
  1. Kim, M. & Kristiansen, E.G. & Vale, B., 2001. "Endogenous Product Differentiation in Credit Markets: What do Borrowers Pay for?," Papers 27/2001, Norwegian School of Economics and Business Administration-.
  2. Juha-Pekka Niinimäki, 2003. "Fairly Priced Deposit Insurance under Adverse Selection," Finnish Economic Papers, Finnish Economic Association, vol. 16(1), pages 38-48, Spring.

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