Diamond and Dybvig's classic theory of financial intermediation : what's missing?
Abstract: The article shows that in a finite-trader version of the Diamond and Dybvig model (1983), the ex ante efficient allocation can be implemented as a unique equilibrium. This is so even in the presence of the sequential service constraint, as emphasized by Wallace (1988), whereby the bank must solve a sequence of maximization problems as depositors contact it at different times. A three-trader example with constant relative risk-aversion utility is used in order to illustrate clearly the requirements that the sequential service constraint imposes on implementation.
Keywords: Bank failures;
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Provider: Federal Reserve Bank of Minneapolis
Part of Series: Quarterly Review
Publication Date: 2000