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Moral Hazard in the Diamond-Dybvig Model of Banking

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Author Info
Andolfatto, David
Nosal, Ed

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Abstract

We modify the Diamond-Dybvig [3] model studied in Green and Lin [5] 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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File URL: http://mpra.ub.uni-muenchen.de/1337/
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 1337.

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Date of creation: 31 Dec 2006
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Handle: RePEc:pra:mprapa:1337

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Related research
Keywords: Banking Private record-keeping Moral hazard Mechanisms Bank runs.

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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  1. David Andolfatto & Ed Nosal & Neil Wallace, 2006. "The role of independence in the Green-Lin Diamond-Dybvig model," Working Paper 0615, Federal Reserve Bank of Cleveland. [Downloadable!]
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  2. Green, Edward J. & Lin, Ping, 2003. "Implementing efficient allocations in a model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 109(1), pages 1-23, March. [Downloadable!] (restricted)
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  3. 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. [Downloadable!] (restricted)
  4. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February. [Downloadable!] (restricted)
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