High interest rates: the golden rule for bank stability in the Diamond-Dybvig model

Jefferson Bertolai () and R. Cavalcanti

No 14-2011, Working Papers from Universidade de São Paulo, Faculdade de Economia, Administração e Contabilidade de Ribeirão Preto

Abstract: In a companion paper, Bertolai et al. (2011) build on Peck-Shell (2003) economies and obtain strong implementation in perturbations of optimal contracts. Since bank runs are eliminated with distortions that become very small when the population grows, a pressing issue is whether an alternative specification can generate the costly crisis that are common in history. We find, in this paper, an affirmative answer in the context of the Diamond-Dybvig (1983) model, and uncover the role played by societal weights on future consumption and solvency risk. An extension of the Ennis-Keister (2009) algorithm shows the impact of run strategies and implicit rates of interest on the formation of expectations, in line with some classical views.

Keywords: severe aggregate-uncertainty; mixed-strategy bank runs; Insolvency; dynamic programmin (search for similar items in EconPapers)
JEL-codes: E4 E5 (search for similar items in EconPapers)
Date: 2011-05-11
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Citations: View citations in EconPapers (1)

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