Government Deposit Insurance and the Diamond-Dybvig Model

J. Huston McCulloch and Min-Teh Yu ()

The Geneva Risk and Insurance Review, 1998, vol. 23, issue 2, 139-149

Abstract: The apparent banking market failure modeled by Diamond and Dybvig [1983] rests on their inconsistently applying their “sequential servicing constraint” to private banks but not to their government deposit insurance agency. Without this inconsistency, banks can provide optimal risk-sharing without tax-based deposit insurance, even when the number of “type 1” agents is stochastic, by employing a “contingent bonus contract.” The threat of disintermediation noted by Jacklin [1987] in the nonstochastic case is still present but can be blocked by contractual trading restrictions. This article complements Wallace [1988], who considers an alternative resolution of this inconsistency. The Geneva Papers on Risk and Insurance Theory (1998) 23, 139–149. doi:10.1023/A:1008626211411

Date: 1998
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