Diamond and Dybvig's classic theory of financial intermediation : what's missing?

Green, Edward J.; Lin, Ping

Journal Article

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;