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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. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  2. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  3. Bruce D. Smith & Cheng Wang, 1997. "Repeated insurance relationships in a costly state verification model: with an application to deposit insurance," Working Papers 574, Federal Reserve Bank of Minneapolis.
  4. 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.
  5. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
  7. Fernando Alvarez & Urban J. Jermann, 1998. "Asset Pricing when Risk Sharing is Limited by Default," NBER Working Papers 6476, National Bureau of Economic Research, Inc.
  8. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  9. V.V. Chari & Ravi Jagannathan, 1984. "Banking Panics," Discussion Papers 618, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
  11. 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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