Moral Hazard in the Diamond-Dybvig Model of Banking
AbstractWe modify the Diamond-Dybvig  model studied in Green and Lin  to incorporate a self-interested banker who has a private record-keeping technology. A public record-keeping device does not exist. We find that there is a trade-off between sophisticated contracts that possess relatively good risk-sharing properties but allocate resources inefficiently for incentive reasons, and simple contracts that possess relatively poor risk-sharing properties but economize on the inefficient use of resources. While this trade-off depends on model parameters, we find that simple contracts prevail under a wide range of empirically plausible parameter values. Although moral hazard in banking may simplify the optimal structure of deposit liabilities, this simple structure does not enhance the prospect of bank runs.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 1337.
Date of creation: 31 Dec 2006
Date of revision:
Banking; Private record-keeping; Moral hazard; Mechanisms; Bank runs;
Other versions of this item:
- David Andolfatto & Ed Nosal, 2006. "Moral hazard in the Diamond-Dybvig model of banking," Working Paper 0623, Federal Reserve Bank of Cleveland.
- Ed Nosal & David Andolfatto, 2007. "Moral Hazard in the Diamond-Dybvig Model of Banking," 2007 Meeting Papers 221, Society for Economic Dynamics.
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
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- Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
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