Unobservable savings, risk sharing and default in the financial system

Ettore Panetti

MPRA Paper from University Library of Munich, Germany

Abstract: In the present paper, I analyze how unobservable savings affect risk sharing and bankruptcy decisions in the financial system. I extend the Diamond and Dybvig (1983) model of financial intermediation to an environment with heterogeneous intermediaries, aggregate uncertainty and agents' hidden borrowing and lending. I demonstrate three results. First, unobservability imposes a burden on financial intermediaries, that in equilibrium are not able to offer a banking contract that balances insurance and incentive motivations. Second, unobservable markets do induce default, but only as long as insurance markets are incomplete. Therefore, their presence is not a rationale for government intervention on bankruptcy via "resolution regimes". Third, even in case of complete markets the competitive equilibrium is inefficient, and a simple tier-1 capital ratio similar to the one proposed in the Basel III Accord implements the efficient allocation.

Keywords: financial intermediation; hidden savings; bankruptcy; insurance; optimal regulation (search for similar items in EconPapers)
JEL-codes: E44 G21 G28 (search for similar items in EconPapers)
Date: 2011-02-10
New Economics Papers: this item is included in nep-ban, nep-cta, nep-dge, nep-ias and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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