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Suspension in a Global-Games version of the Diamond-Dybvig model

Huang, Pidong (2013): Suspension in a Global-Games version of the Diamond-Dybvig model.

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Abstract

This work builds on the model in Goldstein and Pauzner (GP) (2005), a global-games version of the Diamond-Dybvig (DD) (1983) model in which there is uncertainty about the long-term return and in which agents observe noisy signals about that return. GP limited their investigation to a banking contract that makes a noncontingent promised payoff to those who withdraw early until the bank's resources are exhausted. We amend the contract and permit suspension. As we show, there is a class of suspension policies that gives rise to uniqueness without requiring the new assumption introduced in a proof in GP; namely, the short-term return is also random. In general, both the GP policy and my generalization of it to allow suspension seem not to be the best banking contracts. However, if the return uncertainty is sufficiently small, then there are policies in the class we study that imply ex ante welfare close to the first-best outcome in DD, which itself is an upper bound on welfare in the model with return uncertainty.

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