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Risky collateral and deposit insurance

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  • Narayana R. Kocherlakota

Abstract

This paper provides a new rationalization for deposit insurance and systemic disintermediations. I consider an environment in which borrowers face no penalty for failing to repay obligations except the loss of their collateral. I assume that this collateral has aggregate risk. For a subset of the exogenous parameters, I demonstrate that an optimal arrangement features deposit insurance. For a strictly smaller set of parameters, it is optimal in some states of the world to have systemic disintermediation and concomitant falls in real output.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 274.

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Date of creation: 2000
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Handle: RePEc:fip:fedmsr:274

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Keywords: Deposit insurance ; Contracts;

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References

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  1. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  2. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
  4. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  5. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  6. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
  7. Fernando Alvarez & Urban J Jermann, 2010. "Asset Pricing When Risk Sharing is Limited by Default," Levine's Working Paper Archive 1898, David K. Levine.
  8. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  9. V.V. Chari & Ravi Jagannathan, 1984. "Banking Panics," Discussion Papers 618, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Smith, Bruce D. & Wang, Cheng, 1998. "Repeated insurance relationships in a costly state verification model: With an application to deposit insurance," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 207-240, July.
  11. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  12. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
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Citations

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Cited by:
  1. Cristina Arellano & Narayana Kocherlakota, 2008. "Internal Debt Crises and Sovereign Defaults," Levine's Bibliography 122247000000001880, UCLA Department of Economics.
  2. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
  3. Charles M. Kahn & William Roberds, 2002. "Payments settlement under limited enforcement: Private versus public systems," Working Paper 2002-33, Federal Reserve Bank of Atlanta.
  4. Thorsten V. Koppl & James MacGee, 2001. "Limited enforcement and efficient interbank arrangements," Working Papers 608, Federal Reserve Bank of Minneapolis.
  5. Koeppl, Thorsten V. & MacGee, James C., 2009. "What broad banks do, and markets don't: Cross-subsidization," European Economic Review, Elsevier, vol. 53(2), pages 222-236, February.
  6. Thorsten Koeppl & James MacGee, 2005. "What Banks Do and Markets Don't: Cross-subsidization," Working Papers 1052, Queen's University, Department of Economics.

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