Banking, incentive constraints, and demand deposit contracts with nonlinear returns (*)

Ping Lin
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Ping Lin: Department of Economics, Southern Methodist University, Dallas, Texas 75275-0496, USA

Economic Theory, 1996, vol. 8, issue 1, 27-39

Abstract: This paper presents two results regarding banking theory: (1) demand deposit contracts are essential in providing insurance against preferences shocks, as in Diamond and Dybvig (1983), if and only if the incentive compatibility conditions bind at the social optimum; and (2) for additively separable preferences with random discount factors, demand deposit contracts have the realistic feature that the interest rate paid is an increasing function of deposit balance.

Date: 1996
Note: Received: February 13, 1995; revised version April 19, 1995
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