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In Which Context is the Option Clause Desirable?

Author

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  • Mathieu Bédard

    () (Toulouse School of Economics
    Aix-Marseille School of Economics, CNRS and EHESS, Centre de la Vieille Charité)

Abstract

Abstract The option clause is a contractual device from free banking experiences meant to prevent banknote redemption duels. It has been used within the Diamond and Dybvig (J Pol Econ 91: 401–419, 1983) framework to suggest that very simple contractual solutions can act as an alternative to deposit insurance. This literature has, however, been ambiguous on whether the option clause can replace deposit insurance outside of those two contexts. It will be argued that the theoretical clause does not generally affect the likelihood that a solvent bank goes bankrupt because of a bank run, as empirical evidence suggests it is already near null, and that the exercise of the clause will have the effect of diminishing the size of creditor claims on bank assets because it exacerbates the agency problem of bank debt. It will therefore be argued that the clause is only desirable in (a) free banking systems that are historically devoid of bank runs in the first place and have other means of managing debt-related agency problems and (b) under the unrealistic assumption that bank runs are self-fulfilling prophecies. It will be argued that the agency problem of bank debt makes the option clause undesirable outside of free banking systems.

Suggested Citation

  • Mathieu Bédard, 2016. "In Which Context is the Option Clause Desirable?," Journal of Business Ethics, Springer, vol. 139(2), pages 287-297, December.
  • Handle: RePEc:kap:jbuset:v:139:y:2016:i:2:d:10.1007_s10551-015-2611-7
    DOI: 10.1007/s10551-015-2611-7
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial stability; Bank runs; Free banking; Option clause; Insolvency;

    JEL classification:

    • N23 - Economic History - - Financial Markets and Institutions - - - Europe: Pre-1913
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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