Government Deposit Insurance and the Diamond-Dybvig Model
- 318 Downloads
The apparent banking market failure modeled by Diamond and Dybvig  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  in the nonstochastic case is still present but can be blocked by contractual trading restrictions. This article complements Wallace , who considers an alternative resolution of this inconsistency.