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Moral Hazard in the Diamond-Dybvig Model of Banking

Ed Nosal and David Andolfatto ()
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Ed Nosal: Federal Reserve Bank of Cleveland

No 221, 2007 Meeting Papers from Society for Economic Dynamics

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

Date: 2007
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Related works:
Working Paper: Moral hazard in the Diamond-Dybvig model of banking (2006) Downloads
Working Paper: Moral Hazard in the Diamond-Dybvig Model of Banking (2006) Downloads
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