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Risky Collateral and Deposit Insurance

  • Kocherlakota Narayana R

    ()

    (University of Minnesota and Federal Reserve Bank of Minneapolis)

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 distintermediations and concomitant falls in real output.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 1 (2001)
Issue (Month): 1 (February)
Pages: 1-20

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Handle: RePEc:bpj:bejmac:v:advances.1:y:2001:i:1:n:2
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  1. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  3. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  4. Oliver Hart & John Moore, 1998. "Default And Renegotiation: A Dynamic Model Of Debt," The Quarterly Journal of Economics, MIT Press, vol. 113(1), pages 1-41, February.
  5. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
  6. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  7. 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.
  8. Fernando Alvarez & Urban J Jermann, 2010. "Asset Pricing When Risk Sharing is Limited by Default," Levine's Working Paper Archive 1898, David K. Levine.
  9. 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.
  10. V.V. Chari & Ravi Jagannathan, 1984. "Banking Panics," Discussion Papers 618, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Jeffrey Lacker, 2001. "Collateralized Debt as the Optimal Contract," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 842-859, October.
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