Notes on "Bank Runs, Deposit Insurance, and Liquidity" (Douglas W. Diamond, Philip H. Dybvig)

Bank Runs, Deposit Insurance, and Liquidity

Douglas W. Diamond, Philip H. Dybvig

The Journal of political economy,Vol.9, No.3, (Jun.,1983), pp. 401-419

This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Inventions face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibrium, one of which is a bank run. Bank runs in the model cause real economic damage,rather than simply reflecting other problems. Contracts which can prevent runs are studied,and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.

Eurodollar deposits tend to be uninsured and are therefore subject to bank runs, and this is true in the United States as well for deposits above the insured amount.

It is good that deregulation will leave banking more competitive, but we must ensure that banks will not be left vulnerable to runs.

Banks issuing demand deposits can improve on a competitive market by providing better risk sharing among people who need to consume at different random times.
The demand deposit contract providing this improvement has an undesirable equilibrium (a bank run) in which all depositors panic and withdraw immediately, including even those who would prefer to leave their deposits in if they were not concerned about the bank failing.
Bank runs cause real economic problems because even"healthy" banks can fail, causing the recall of loans and the termination of productive investment.

Banks are able to transform illiquid asset by offering liabilities with a different, smoother pattern of returns over time than the illiquid asset after 
-> confident-> risk sharing
-> panic -> bank run

Fisher (1911, p64)

A run occurs because the bank's assets, which are liquid but risky, no longer cover the nominally fixed liability (demand deposits), so depositors withdraw quickly cut their losses.

There is a feasible contract that allows banks both to prevent runs and to provide optimal risk sharing by converting illiquid assets

Model:

• An economy with a single bank (representing the financial intermediary industry)
• Deposit insurance dominates contracts which the bank alone can enforce shows that there is a potential benefit from government intervention into banking market
• There is a trade-off between optimal risk sharing and proper incentives for portfolio choice.
• The Fed discount window can, as a leader of last resort, provide a service similar to deposit insurance.
• If the technology is risky, the lender of last resort can no longer be as credible as deposit insurance.
• If the lenders of last resort were always required to bail out banks with liquidity problems, there would be perverse incentives for banks take on risk, even if bailouts  occurred only when many banks fail together.
• If the lender of last resort is not required to bail out banks unconditionally, a bank run can occur in response to changes in depositor expectations about the bank's credit worthiness.

Notes on "More Insurers Lower Premiums: Evidence from Initial Pricing in the Health Insurance Marketplaces" (Leemore Dafney, Christopher Ody and Jonathan Gruber)

More Insurers Lower Premiums: Evidence from Initial Pricing in the Health Insurance Marketplaces

Leemore Dafney

Kellogg School of Management, Northwester University and NBER

Jonathan Gruber

Massachusetts Institute of Technology and NBER 

Christopher Ody

Kellogg School of Management, Northwester University

July, 2014

Federal health insurance subsidies are only available to those who purchase a policy through Health Insurance Marketplaces (HIMs), only known as exchanges.

The success of HIMs will depend on attracting both consumers and insurers.

Competition can only have its salutary effects if there are competitors.

Prior to the ACA, health insurance markets were very concentrated.

This study builds on existing research on competition among private insurers.

Instrument is similar in spirit to that used by Dafry et al (2012).

(Econometrics)

Exchange premiums are responsive to competition

HIMs have not (to date) produced a Bertsand-like outcome in which a small number of players can drive premiums chum to cost.

Future entry:

there is room for significant learning on both scales of this market:

Changes in the sharper of consumes demand curves will in turn affect pricing. Relatedly, insures' uncertainty about who their competitors will be, what the pool of consumers will look like, and what kinds of products will be attractive to those consumers will resolve. What impossible to sign definitely, most of there are likely to make the cross-price elasticities of demand across insurers higher for a given market structure. Under these circumstances, margins will decline faster with a more from one to two insurers. Once pricing nears the competitors will have a smaller incremental effect.

Notes on "Financial Shocks and Labor Market Fluctuations" (Francesco Zanetti)

Financial Shocks and Labor Market Fluctuations

Francesco Zanetti

University of Oxford

May 2015

Recent research shows that shocks that originate in the financial sector are important factors in explaining business cycle fluctuations.

Estimate the (real business cycle) model using Bayesian methods

Impulse response functions of the estimated model show that financial shocks are powerful in altering the firm’s flows of financing and labor market variables such as vacancy posting unemployment and wages.

The wage equals the marginal rate of substitution between consumption and leisure plus current lining costs minus the expected savings in terms of the future hiring costs if the match continues in period t+1

The firm increases the employment shock nt+1 available during period

The firm maximizes its total real expected equity payment

Measures the marginal utility value depend on:

1. the marginal product of labor
2. the cost of living an extra worker

Empirical test:

• the sharp increase in vacancies and fall in unemployment raises labor market tightness, which in turn increases the cost of posting vacancies, reducing the wage
• the increase in output induces the firm to adjust its financial position by raising equity payouts and reducing debt issuing
• the shock increases unemployment and reduces output and investment
• the fall in consumption decreases the marginal rate of substitution between consumption and leisure
• shocks to the job distraction rate are important for the dynamics of the unemployment rate

The paper states:

• financial shocks are an important source of fluctuations in wages
• shocks to the job destruction rate are important for unemployment fluctuation, thereby suggesting that including an endogenous job destruction rate would certainly be a useful extension
• it would be interesting to enrich the theoretical framework with nominal rigidities and extend the analysis to include a monetary authority and nominal variables such as inflation.

Notes on "Do Stock Prices More Too Much to be Justified by Subsequent Changes in Dividends?" (Robert J. Shiller)

Do Stock Prices More Too Much to be Justified by Subsequent Changes in Dividends? 

By Robert J. Shiller (June 1981) 

A simple model that is commonly used to interpret movements in corporate common stock price indexes asserts that real stock prices equal the present value of rationally expected or optionally forecasted future real dividends discounted by a constant read discount rate. 

Stock price indexes seem too "volatile",=>the movement in stock prices indexes could not realistically be attributed to any objective new information, since movement in the price indexes seem to be " too big" relative to actual subsequent events. 

the Great Depression:

real dividends were substantially below their long-run exponential growth path only for a few depression years: 1933, 1934, 1935 and 1938.

Merton Miller and Franco Modigliani argued, such present value formula would entail on fundamental sort of double counting. It is incorrect to include in the present value formula both earnings at time t and the later earnings that accrue when time t earnings are reinvented. Muller and Modigliani showed a formula by which price might be regarded as the present value of earnings corrected for investments. 

The standard deviation of the fitted value divided by average detrended price is 5.24 and 8.67 percent. 

Measures of stock price volatility over the past century appear to be far too high -five to thirteen times too high - to be attributed to new information about future real dividends if uncertainty about future dividends is measured by the sample standard alterations of real dividends around their long- run exponential growth path. 

One way of saving the general notion of efficient markets would be to attribute the movements m stock prices to changes m expected real interest rates. 

Another way of saving the general notion of efficient markets is to say that our measure of the uncertainty regarding future dividends- the sample standard deviation of the movements of real dividends around their long-run exponential uncertainty about future dividends. 

Such as explanation of the volatility of stock prices,however is "academic" , in that it relies fundamentally on unobservables and can not be evaluated statistically . 

Notes on "An optimizing neuroeconomic model of Discrete Choice" (Michael Woodford)

An Optimizing neuroeconomic model of Discrete Choice

Michael Woodford 

Columbia University, Feb 2,2014

The stochastiaty of choice

• reasons to prefer the interpretation of stochastic choice as representing random errors in cognition processing, Alain to random errors in perception:
• when random preference can be hypothesised that would account for observed data as trial- by- trial optimal choices, the kind of variation in preference required is not equally plausible
• a longstanding literature in experimental psychology and neuroscience has documented the randomness of the responses that subjects given when asked to make perceptual judgement, in a variety of sensory domains.
• in economic choices just as in the care of perceptual taxes, there is observed to be  a sybemat relation between the time required for experimental subject to make a decision and the characteristic of the alternations, specifically the average response time is shorter in the care of" easier" choices, which are also the ones for which repeated trials yield the same response a greater fraction of the time 
• the hypnosis that choice are based on errors, however, rather than on DMs' true preference , has some potentially unappealing features, in the absence of a more specific theory about the picture of the errors

drift- diffusion model

• a continons-valued subjective state variable, that one may think of as an evolving perception of the weight of sensory evidence in favor one response relative to the other, follows a random walk with drift on a bounded internal, a decision is made in favor of one or the other of the two responses when the bound corresponding to that decision is reached

As information - constrained dynamic model of discrete choice

• poison

The predictions of the OICM and the DM are not identical 

a common feature of experimental data on response times in binary perceptual classification tasks as well and is a famous empirical falling of the DDM. The OICM instead correctly predicts that correct choices should be made more quickly and by roughly the amount by which the mean response times are different in the data.

The OICM's predictions regarding response times are also more accurate than those of the basic (unconstrained) RI model, which is as successful as the DDM in explaining the data on choice frequencies alone.

predictions of RI are obtained under the assumption that response time has no consequences for reward

this model weakness:

        it generally over- predicts the variability of response times.